Re-Distributional Effects of Austerity Measures

Abstract

We have argued that a reduction in government expenditure will result in re-distributional effects arising from the re-shifting of resources from the public to the private sector. Since new funds are now available for savings the effect is likely to be felt, first of all, in the profitability of the banking sector and its overall stability. This is important because it is a common misconception that financial stability is endangered during a recessionary period if the government does not act in an expansionary manner. In fact, quite the opposite is true. First of all, the commercial banks are not forced to buy government debt and create an artificial credit expansion whose final effects will be quite the opposite from what the government intended. Second, financial stability is maintained in the short-run by the transformation of expenditure cuts to savings. Third, if we have a reduction of public debt it is hard to see how overall financial stability is hampered by the austerity measures. The question is whether we will have, indeed, a reduction of public debt. Accommodation of interest payments would seem impossible in the short-run unless the measures are accompanied by a re-structuring of the tax system which yields higher tax revenues.