The Global Economy & European Debt Crisis: U.S. Fiscal Policy - Austerity and Stimulus (2012)

In economics, austerity describes policies used by governments to reduce budget deficits during adverse economic conditions. These policies may include spending cuts, tax increases, or a mixture of the two. Austerity policies may be attempts to demonstrate governments' liquidity to their creditors and credit rating agencies by bringing fiscal incomes closer to expenditures.

In macroeconomics, reducing government deficits generally increases unemployment in the short run. This increases safety net spending and reduces tax revenues, to some extent. Government spending contributes to gross domestic product (GDP), so the debt-to-GDP ratio, an index of liquidity, may not immediately improve. Short-term deficit spending contributes to GDP growth particularly when consumers and businesses are unwilling or unable to spend. Under the controversial theory of expansionary fiscal contraction (EFC), a major reduction in government spending can change future expectations about taxes and government spending, encouraging private consumption and resulting in overall economic expansion.

Initial austerity results in Europe have been as predicted by macroeconomics, with unemployment rising to record levels and debt-to-GDP ratios rising, despite reductions in budget deficits relative to GDP. Eurostat reported that unemployment in the 17 Euro area countries (EA17) reached record levels in March 2013, at 12.1%,[8] up from 11.0% in March 2012 and 10.3% in March 2011;[9] and that the overall debt-to-GDP ratio for the EA17 was 70.1% in 2008, 80.0% in 2009, 85.4% in 2010, 87.3% in 2011, and 90.6% in 2012.[10][11][12] Further, real GDP in the EA17 declined for six straight quarters from Q4 2011 to Q1 2013.[13] The U.S. Congressional Budget Office estimated in August 2012 that if the U.S. implemented moderate austerity measures, the unemployment rate would rise by over 1% and economic growth would be significantly reduced in 2013.[14] The U.S. partially avoided the "fiscal cliff" through the American Taxpayer Relief Act of 2012. U.S. unemployment has fallen steadily from a peak of 10% in early 2010 to 7.6% by March 2013.

http://en.wikipedia.org/wiki/Austerity