Fiscal austerity in the developed world represents a paradox. On one hand, it is necessary as governments had already borrowed too much going into the crisis and can thus no longer continue to lever up to compensate for private deleveraging. On the other hand, the objective of fiscal austerity is to stabilise exploding government debt to GDP ratios, but this is proving difficult as depressing government spending leads to a higher decline in GDP relative to the reduction in the gross debt level.
The end result is that the government debt to GDP ratio goes up even as the budget deficit is lowered.
Some would claim that it is better for the government to spend today and save tomorrow, but it is exactly governments’ ability to do this which is no longer available. This links in with our view that the next decade will see sovereign defaults of several developed economies.