"The Only Sensible Policy in a Debt Crisis is an Austerity Programme". Discuss this statement with particular reference to unemployment.

Topics: Macroeconomics, Economics, Inflation Pages: 4 (1317 words) Published: January 30, 2014
"The Only Sensible Policy in a Debt Crisis is an Austerity Programme". Discuss this statement with particular reference to unemployment. -- Terri Ha

A debt crisis is the situation an economy is facing when its borrowings for spending is much greater than its tax revenue, that its public debt is increasing to a point where it is almost impossible to manage. an austerity programme is a series of government imposed policies to manage this debt, including a reduction in government spending and an increase in taxation. In a debt crisis, there is no doubt that a series of reforms must be made to pay back the debt and interests to avoid bank default. Although reducing spending and increasing taxation may seem like the most straightforward thing to do, we must remain skeptical in whether this is the “only sensible policy” there is to solving this crisis. To reach a logical evaluation of this statement, we must consider the effectiveness of this policy and the availability of other policies that may reach a similar goal of reducing debt.

On one hand an austerity programme is able to manage the debt to GDP ratio of an economy. By cutting government spending, a country will need to borrow less money, and there will be a smaller pile on of debt. The country will not have to pay back such an enormous sum of money plus interest rates. By increasing taxation, the government will have a larger bank of money, that can be used to pay back the debt plus interest rates. For example, if Andorra’s spending went down from $600m a year to $500m a year, and its total tax revenue went up from $500m a year to $600m a year, then the economy would go from a $100m deficit to a %100 surplus. At this rate, it seems logical that the debt crisis will be solved.

However, an austerity programme could have a negative effect on the economy and possibly make the debt crisis even worse. This cut in government spending will lead to a vicious cycle of depressed consumption and higher rates of...
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