What is austerity and what does it mean for my money?

Prime Minister Rishi Sunak has denied claims that his policies will lead the UK back into a period of austerity. The policy was adopted in Britain following the 2008 financial crisis and led to cuts to public services including healthcare, welfare and education. But what does austerity mean for my money?

The biggest headline announcement from the Autumn Statement was a 2% cut to National Insurance rates for 27 million UK workers. Two million self-employed were also granted NI savings, while tax breaks for businesses were extended in a package worth £4.3 billion over the next five years.

Jeremy Hunt was keen to show that a Conservative government was able to cut taxes in the run up to the next General Election. But critics quickly responded with claims that the measures would come at the expense of public spending and herald a return to austerity.

The Institute for Fiscal Studies warned that they would result in budget cuts of more than £20 billion for unprotected departments – like prisons, housing and local government – by 2027/28. Claims that were rebuffed by Sunak.

In this article, we cover:

• What is austerity and how does it work?
• When did austerity start in the UK and why was it introduced?
• Did austerity work in the UK? 
• Is the UK headed for austerity?
• How can you protect your money from austerity?

Read more: When will interest rates go down?

What is austerity and how does it work?

The word austerity brings up images of bleak Dickensian England and a certain meanness that was epitomised by the writer’s most famous miser, Scrooge, in A Christmas Carol. But it is also an economic term.

Austerity is a policy used to describe the measures employed by governments to reduce their debts.

Typically this means tightening the purse strings and reducing public spending. But it can also involve increasing revenues by raising taxes. 

This doesn’t necessarily have to mean increasing tax rates, the same effect can be achieved more stealthily by freezing tax thresholds which results in so-called fiscal drag.

A government is likely to start adopting austerity measures during periods of economic uncertainty or low growth, when it is concerned that it might otherwise struggle to repay its debts.

Read more: How do banks make money and what do they do with yours

What are the pros and cons of austerity?

There is no consensus among economists and policymakers whether austerity can be a good measure for a country or a bad one. There are a number of considerations.

Pros:

• Austerity could reduce reliance on borrowing
• Reducing the budget deficit – this is money that a government has agreed to spend but does not have
• Can improve overall confidence in the economy and increase private investment
• Short-term pain may mean that future generations are not saddled with a debt burden
• A ‘moral’ principle – austerity reinforces the message that everyone, including governments, should not spend money they don’t have 

Cons:

• Austerity means less money is likely spent on public services – from libraries and bin collections to schools and hospitals
• Can increase regional inequalities
• The tax burden on households may rise
• Job losses may increase
• Austerity may lead to an increase in poverty and homelessness
• It may depress economic growth and result in lower tax revenues (which undoes the benefits of reduced public spending)

When did austerity start in the UK and why was it introduced?

The period of austerity most of us are familiar with were the years between 2010 and 2019 which was kicked off by the Conservative/Liberal Democrat coalition. The then Prime Minister David Cameron set the ball rolling in 2009 when he said that “the age of irresponsibility” needed to give way to the “age of austerity”.

The government was forced to bail out a range of UK banks during the financial crisis. As a result, borrowing shot up from £41 billion in 2007/08 to £111 billion the following year and £152 billion the year after that. Public borrowing only dropped to pre-crisis levels in 2018.

During the austerity years, the government reduced its spending by more than £30 billion. This involved drastic cuts to the welfare bill, local government, policing and housing. Education took a major hit as well when the Building Schools for the Future program was scrapped in 2010.

Did austerity work in the UK? 

David Cameron argued that, with the budget deficit at a record high, a period of austerity was unavoidable. 

However, critics claim that it led to an extended period of low wages and depressed economic growth. It’s also highly likely that its impact contributed to the decision to hold the Brexit referendum in 2016.

A report from the Progressive Economy Forum, concluded that Britain’s debts could have been reduced without such brutal cuts to public spending. After analysing Office for Budget Responsibility figures, the think tank claimed that the cost of not maintaining historic levels of public spending came to £540 billion over the decade.

Economist and author of the report, Jo Michell said: “We have found no evidence for the claims made by governments implementing spending cuts that austerity would support economic recovery after the financial crisis.”

“Instead of promoting growth by boosting economic confidence, this research shows that the programme undermined wages and conditions at work, and cost public services hundreds of billions of pounds.”

Is the UK headed for austerity?

The recent Autumn Statement wasn’t the first time that it’s been suggested we are entering a new era of austerity.

The Covid-19 pandemic led to another significant spike in government borrowing, reaching £330.1 billion in 2020/21, up from £68.3 billion the previous year.

And, while the UK isn’t currently in recession, the outlook for the economy is not great. GDP growth is minimal and inflation, although dropping to 4.7% in October, still remains well above its 2% target, raising concerns that the UK could be headed towards a period of stagflation.

There are also no signs of interest rates starting to fall. Andrew Bailey, governor of the Bank of England, stated recently that they won’t be cut within the ‘foreseeable future’.

But while that might mean there is now a similar rationale for austerity, as there was in 2009, tough lessons have been learned in that time. 

Economist Dr Robert Calvert Jump, another author of the PEF report warned: “A return to spending cuts in the wake of the Covid-19 pandemic would inflict a similar, dramatic cost on an economy that has barely recovered from the last round of cuts.”

The current government will also be loath to use the word ‘austerity’ in the run up to a general election.

How can you protect your money from austerity?

Whether or not we are in, or entering, another period of austerity is almost a moot point.

Rather than focusing on economic labels, it’s better to focus on what is happening to the UK economy and the impact that is likely to have on inflation and interest rates.

And with the prospect of a recession not ruled out for the coming year, it does make sense to explore ways of recession-proofing your own personal finances.

This can include: 

1. Staying on top of your debts

With interest rates high and likely to remain that way for some time, it’s important to pay down your debts and ensure you are always getting the best deal that you can on everything from your mortgage to credit cards and personal loans. Be wary of borrowing more unless you can’t avoid it

2. Growing your cash buffer

It’s always sensible to have a financial safety net in the form of three to six months expenses in an instant access savings account, but it’s particularly wise during periods of economic uncertainty.  With interest rates unlikely to rise further any time soon, the period for the best savings rates may have passed, but it’s still worth shopping around for the best savings accounts. This is especially if you haven’t reviewed yours in a while.

3. Looking to the future

If you don’t have debts beyond your mortgage and have enough money set aside in savings accounts, it makes sense to think about growing your wealth over the long term.  If you can afford to tie your money up for at least five years, it might be worth drip feeding your spare cash into the stock market with a stocks and shares ISA.

Find out how to make it work with our beginner’s guide to investing.