Working Paper

The Austerity Trap: A Century of Unrest and Budget Cuts

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Budget cuts can be dangerous. Inspired by the wrenching experience in Greece, increasing attention is now being paid to the fact that austerity may fail to reduce the government deficit if the economy declines in response, as is likely in a liquidity trap (Delong and Summers 2012).

In this short paper, we point out a second channel through which austerity may be self‐defeating. When government budget cuts lead to a backlash on the streets in the form of unrest and politically‐motivated violence, uncertainty increases. This in turn reduces growth. Investments are postponed, workers not hired until the uncertainty resolves itself. We first survey the evidence linking austerity with social and political instability, and then turn to the consequences for output.