The practice of government austerity, defined as the raising of taxes and lowering of spending to improve the government's balance sheet, is not what the United States needs right now. Here's why.
The economy can basically be summed up as the total number of goods and services produced in the country. The measure for that is GDP. At present GDP is growing, but at a very slow rate.
Also at present, private American citizens are deleveraging in aggregate, or paying down their debt loads together. They're doing it at a faster rate than the citizens of many other developed economies with high private debt.
In the economy, one person's spending is another's income and vice versa. The banker who buys a latte at Starbucks helps pay for the barista's salary, while the interest paid on the barista's credit cards helps pay for the banker's salary.
The economy grows from year to year as people produce more (and more valuable) goods and services. Some people spend less than they make and save the rest, while some others spend more than they make. It's not all spendthrifts who do the latter; retirees, for instance, spend more than their incomes as they live off of their retirement savings. An entrepreneur bootstrapping a new business would also be expected to spend more than his or her income.
Under normal circumstances, there will be a good mix of people spending less than they make and spending more than they make. We don't have that now. Far more people are looking to spend less than they make than the opposite as they pay down their debts and/or increase savings. The large number of people who are behind or underwater on mortgages are a significant part of those net savers. Their preference will be to pay down that debt no matter how alluring increased consumption becomes. This state of affairs has become known as a balance sheet recession.
Due to the deleveraging, economic activity in the private sector is lower than it otherwise would be. Due to high unemployment, it's really lower than it otherwise would be. Only two things could compensate for it. One is running a trade surplus, but the country hasn't done than since the 1960s.
The other is if the government steps in and spends more than it takes in by running a deficit. It does that already, of course, and has for many years.
Now let's think about government austerity. The government would roll back its economic activity by spending less, and it would further inhibit private sector activity by raising taxes. Some people claim that an austerity program would help the economy by unleashing a flood of economic activity currently held back by people worried about a potential sovereign debt crisis in America. I don't see it.
If regular people were only just saving money, I might believe that. They're not. They're paying down debts, and they will continue to do so until their overall level of debt is sustainable. Most regular people also pay no attention to current events, have no idea what the state of the government's debt is other than "it's big", and do not think about future tax rates when planning purchases.
Cutting back government economic activity right now will just hurt the economy. That will just put more people out of work, thereby slowing economic growth. Growth is already slow right now; cutting back on government spending might cause the economy to shrink as it has in some European countries. Austerity in a bad economy is self-defeating in that way. If the economy shrinks, the government collects fewer taxes and can't reduce its deficits as quickly as it had intended to (or at all, if it's a severe case).
The government can try to jump start the economy by doing more spending, but it must do it smartly. Passing out tax rebate checks probably won't get the job done, as many of them will just go to paying off debt. That might bring the ultimate end of the deleveraging cycle a tiny bit closer, but $400 or $800 is peanuts compared to a mortgage.
It'd be better to use it to directly employ people and invest. Have state and local governments re-hire teachers, police officers, and firemen who have been laid off. The government could fix the nation's infrastructure and put construction workers back to work, something that will benefit everyone. High unemployment takes a toll, and long term unemployment takes an even larger one.
I am still working to understand economics better and figure out what is the best way forward. I'm not sure of a lot of things, but that austerity would be bad for the US is one thing I'm certain of.
