I keep hearing about how many European nations have put into place austerity measures to try and come out of the recession. I've heard people in the US say that we should implement the same measures here but have also heard others say that they wouldn't help. Do austerity measures work?
The austerity craze in Europe is headed primarily by Germany who, by the way, also attempted austerity during their post-WW1 recession which contributed strongly to their total economic collapse. The US also tried austerity during the period immediately following start of the Great Depression, and see where that got us? Austerity doesn't work to resolve the problems of a recession and it never will. Let's look at the reason why:
During a recession, some of the primary conditions are
1) High unemployment
2) Low wages
3) High debt defaults
4) Surplus inventories not being bought
5) Deflationary pressures pushing prices down
Basically, businesses fire people and sell off assets in order to decrease the costs associated with production potential in excess of that required to meet market demand - market demand is, of course, small during this time because employment and wages are down.
In order to stimulate economic growth, those surplus inventories must first be depleted so that businesses will be forced to hire people once again to increase production. This is best accomplished when a government pursues infrastructure projects. The high labor requirements and high amount of resource demand of such projects increase short-term hiring which depletes surplus inventories of both business and consumer goods, generating longer-term employment as businesses increase hiring for permanent rather than temp or project work. At the same time, it is in the nature of infrastructure that it decreases costs and increases production potential for businesses and individuals who take advantage of it. For example, a healthy road system has more production potential than no roads at all for those businesses who use roads to ship supplies and their products, and whose employees drive to work.
Austerity, on the other hand, ensures that the economy does not produce anything. Think of it like this: if you lose your job you're not making any money, but you don't sell your car - instead, you spend some money to put gas in your car so you can find a new job. It's all about the return on investment - spending a little in the short-term generates long-term gains. Once you get your new job, then you can pay off your debt because you're making money, again.
Governments can only pay off their debts when they are making money. They make money through tax and fee revenues, which increase when the economy is healthy. So, in order for the government to make money, they must make capital investments that will increase the profitability of businesses, the income of people, and the health of the economy.
If you walk away from this with anything, remember that the role of government spending is more alike to an entrepreneur investing in things that will generate future income, than it is alike to a household budget.