The good, bad and ugly of austerity.

The biggest roadblock to convincing somebody about the merits of what you believe in is your conception of it. This is to true for many thing including whether you think austerity is good or bad. I will take a broad view of austerity that entails not only trimming the budget but also raising taxes of various types. Such a thing can be good, bad and ugly at the same time.

Let's start with the bad. Austerity can be counterproductive in tough times like these. Just like raising taxes too much is probably going to reduce tax revenues as people work less and evade taxes, so will cutting spending in times of economic difficult actually increase the deficit. Cutting spending can be a good thing in the long run but its immediate effect is going to be bad. To take an example, let's say government lays off personnel, a part of the money it saves by firing them must go to them as unemployment benefits. If you decide that's too much welfare and cut that too, these people will have little money to spend on the necessities of life and will be forced to borrow or steal. Here's where austerity gets really ugly. Cutting social services will not automatically enrich the people and push them to spend. That will happen only if you cut taxes simultaneously. Unfortunately, taking that course takes you back to square one-any money saved from not spending is compensated by lower tax revenue. Lower taxes however only makes sense if people have employment in the first place. State employees will not be magically integrated into the private sector. And so, if you take all the aforementioned steps you're going to end up with less social services, weaker economy and higher debt.

That however still isn't such a bad thing. If the money given back to the people in the form of lower taxes gives them an impetus to spend more, it will make for the lost pubic investment.

A penny saved is a penny lost (to the government)

According to The Telegraph, British savers are expected to lose up to £33 billion over the next three years if the current monetary policy of keeping interest rates low and inflation high continues. Although the inflation rate has subsided ever so slightly it still remains high enough for the value of people's deposits to depreciate. This cost is the unseen cost of Britain's high public debt; a form of invisible taxation that takes money from the thrifty to fund the government's expenses. Only a correction in fiscal policy will allow Bank of England (BoE) to change its stance and save the 'savers'. 

10-yr government bond yields for the UK is 2.67% as opposed to Greece's 10%. Although many differences exist between the two economies, there is one major difference. There is no Greek Central Bank that prints Drachma while we have the BoE that churns out Pounds. Without this monetary sovereignty, the Greek government debt cannot be neutralized through bond purchases. If Greece did have a Bank of its own, it would most likely do just that. The cost of additional debt would then be shifted to the savers without having to push up bond yield rates to attract wary investors. This is what is happening in the UK now.

The UK is able to keep spending more than it earns without having to pay more for the borrowing it needs to fund the deficit thanks to BoE's explicit policy to keep interest rates low. However, there is no free lunch here. The deficit instead is paid for by savers blissfully unaware that they're paying for the government's fiscal follies. If the government doesn't genuinely cut spending, BoE would have to keep interest rates longer to avoid Greece's fate of nearly defaulting. That however means that inflation will pick up while interest rates remain low, wiping out the real value of people's deposits. 

Wiping out the deposits of savers is unlikely to boost confidence in the populace. This means more bad news for the economy and for government finances that depend on it. This is the paradox of expansionary fiscal policy. If the government spends more, it either has to pay it through higher bond yield payments or by reducing people's real wealth making them poorer and reducing economic growth.