Introduction
As the world evolved, so did ideas and theories revolving round the economics of
austerity. Many debates ensued over the effectiveness of implementing austerity
measures in a depressed economy, with economists arguing it would deepen the
depression and delay recovery. This paper will discuss the effects of a country’s debt
on its economy, with references to “Growth in a time of debt” by Reinhart and Rogoff
(2010) and the critique by Hendon, Ash and Pollin (2013). In addition, this paper will
also discuss the austerity measures implemented in Greece and the United Kingdom
since 2010, and the rationality of austerity programs to reduce sovereign debt.
It is vital to first understand the different economic views on government expenditure
and how the Keynesian Multiplier works to be able to explain why government
spending during a recession may boost investments and aggregate demand.
Economic views on government expenditure
The Classical economic theory revolves round the concept of a laissez-faire market.
Say’s Law states that ‘the supply of goods and services calls forth its own demand’,
hence classical economists believe that the economy will correct itself and there is no
need for government interference in times of recession. The major assumption of the
classical model is that the economy is always at full capacity and any increase in
supply will raise income and therefore lead to an increase in demand. Government
expenditure is not a major force in the classical model as they believe involvement will
hinder the country’s economic growth and cause crowding-out of private sector
investments.
On the other hand, the Keynesian theory relies on spending and aggregate demand
(AD = C + I + G + X - M) and how change in transactions in the factor, goods and
financial markets will influence aggregate demand, which in turn affect total output
commonly measured by Gross Domestic Product (GDP). Contrary to the Classical
model, Keynesian economics believe that government spending in times of sluggish
downturns and recession can jumpstart a country’s economic growth. Keynesian
As the world evolved, so did ideas and theories revolving round the economics of
austerity. Many debates ensued over the effectiveness of implementing austerity
measures in a depressed economy, with economists arguing it would deepen the
depression and delay recovery. This paper will discuss the effects of a country’s debt
on its economy, with references to “Growth in a time of debt” by Reinhart and Rogoff
(2010) and the critique by Hendon, Ash and Pollin (2013). In addition, this paper will
also discuss the austerity measures implemented in Greece and the United Kingdom
since 2010, and the rationality of austerity programs to reduce sovereign debt.
It is vital to first understand the different economic views on government expenditure
and how the Keynesian Multiplier works to be able to explain why government
spending during a recession may boost investments and aggregate demand.
Economic views on government expenditure
The Classical economic theory revolves round the concept of a laissez-faire market.
Say’s Law states that ‘the supply of goods and services calls forth its own demand’,
hence classical economists believe that the economy will correct itself and there is no
need for government interference in times of recession. The major assumption of the
classical model is that the economy is always at full capacity and any increase in
supply will raise income and therefore lead to an increase in demand. Government
expenditure is not a major force in the classical model as they believe involvement will
hinder the country’s economic growth and cause crowding-out of private sector
investments.
On the other hand, the Keynesian theory relies on spending and aggregate demand
(AD = C + I + G + X - M) and how change in transactions in the factor, goods and
financial markets will influence aggregate demand, which in turn affect total output
commonly measured by Gross Domestic Product (GDP). Contrary to the Classical
model, Keynesian economics believe that government spending in times of sluggish
downturns and recession can jumpstart a country’s economic growth. Keynesian
