IAS Economy Practice Question . 7

Many countries, specially in Europe in recent times have adopted the “Austerity Measures”. What are “Austerity measures”?
1. They are typically taken in a situation where a country is on brink of sovereign default
2. They are characterized by cuts in development projects, welfare, and other social spending
3. One of the objectives of Austerity measures is to reduce Fiscal deficit
Choose the correct option:
[A]Only 1 is correct
[B]Only 1 & 2 are correct
[C]Only 2 & 3 are correct
[D]1, 2 & 3 are correct

Answer: 1, 2 & 3 are correct
Austerity measures are typically taken if there is a threat that government cannot honor its debt liabilities. Such a situation may arise if a government has borrowed in foreign currencies which they have no right to issue or they have been legally forbidden from issuing their own currency. In such a situation banks may lose trust in government’s ability and/or willingness to pay and refuse to roll over existing debts or demand exorbitant interest rates. In such situations, inter-governmental institutions such as the International Monetary Fund (IMF) typically come in and demand austerity measures in exchange for functioning as a lender of last resort. When the IMF requires such a policy, the terms are known as ‘IMF conditionalities’.

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