Austerity is a hugely important and controversial topic in contemporary economics and in current political discussion. By austerity, we will mean a programme of planned reductions in a government's budget deficit over a period of time, brought about by some combination of reductions in government spending and increases in taxation which will, if successful, stabilize or reduce the government debt–GDP ratio. Governments that have large debt–GDP ratios, or ratios that are increasing rapidly, may be under considerable pressure to adopt austerity policies.

To be clear on terminology at the outset: the budget deficit is the difference between the government's total spending and its total revenue from taxation and other sources.1 The debt is the total amount of its outstanding borrowing. The deficit is a flow measure; the debt is a stock. The deficit adds to the debt. Usually, what matters is not the absolute size of deficits and debt, but their magnitude relative to a measure of economic activity, such as GDP. Other important concepts are the primary deficit, which is what the deficit would be if interest payments on the debt were excluded, and the structural deficit, which is what the deficit would be were the economy at full employment (or at some other reference level of output).

The appropriate levels of taxation and government spending (and the consequential budget deficits or surpluses) have always been important issues. However, they surged in importance in the aftermath of the Great Financial Crisis (henceforth GFC) of 2007–08, when many countries experienced large increases in their budget deficits. A fall in tax revenues as output fell, increases in expenditure (such as social security) due to the decline of output and employment, discretionary measures undertaken to combat the deflationary effects of the crisis and the bailing out and support of financial institutions all contributed to the rapid increase in fiscal deficits.

Many governments were in an acute dilemma. On the one hand, interest rates had been reduced by as much as they could feasibly be, so conventional monetary policy could not be used any further for stabilization purposes. Hence there seemed to be a strong case for expansionary fiscal policy. But on the other hand, the large fiscal deficits meant rapidly escalating debt, with extremely damaging consequences if that were to continue.