The coming academic year will pose the greatest budgetary challenges the Faculty of Arts and Sciences has faced since the Great Recession struck in 2008, as FAS Dean Michael D. Smith has predicted over the past few months.

The University’s largest school made considerable progress since early 2009, closing nearly $185 million of a $220 million deficit. Now Smith pledges to eliminate the remaining $35 million deficit by the summer of 2012.

“Dean Smith has often stressed that this year would be the most challenging financially,” FAS spokesman Jeff Neal wrote in an e-mail yesterday.

Yesterday’s announcement that the University’s endowment increased 11 percent in the past year, bringing the overall endowment to $27.4 billion, could offer sought-after relief for next year’s budget.

But this year, FAS is working with a 12-percent reduction in the annual endowment payout—around 50 percent of its budget—determined by the Harvard Corporation, the University’s highest governing body.

Departmental budgets could face further strain as a result of a two-year contract agreement struck between the University and the Harvard Union of Clerical and Technical Workers in July. The contract provides many staff members a $1,000 raise this fiscal year.

FAS is now planning for what it has labeled “phase three” of its financial recovery process, involving cost-cutting measures with structural, long-term ramifications. Indeed, department leaders said in interviews with The Crimson that after two years of incremental cuts, the discourse has steered away from budget-slashing to larger restructuring.

“Two years ago, almost every week, every day, we were meeting about how to cut the budget,” said Math Department Chair Shing-Tung Yau. “Now we are talking about how to serve the students better.”

Yau said that his department is once again discussing the possibility of hiring more professors—a development he regards as a welcome change from the past two years, when the department operated under the FAS-wide slow-down on faculty searches.

In the wake of the financial crisis in the fall of 2008, when the University endowment fell by 30 percent, FAS found itself $220 million in the red. The school responded to the crisis with 15-percent budgetary reductions in academic departments and an early retirement package for staff workers. Those measures “generated immediate savings,” according to Neal.

In continuing its emphasis on budgetary oversight, FAS introduced last year the “first dollar principle,” through which Smith aimed to spend FAS’ restricted funds—money with limitations on how it may be spent because of donor specifications—before spending the school’s unrestricted funds.

More details about the current state of the budget, FAS’ approach to the cuts, and Smith’s priorities in the coming year will be announced at the next Faculty meeting on Oct. 6, according to Neal.

For now, departments are coping with whatever they can get. Gennaro Chierchia, chair of the Linguistics Department, said his department was granted a part-time replacement to fill in for a departed staffer.

“And that is a big help, especially in a small department, because every little thing counts,” he noted.

—Staff writer Noah S. Rayman can be reached at nrayman@fas.harvard.edu.

—Staff writer Elyssa A.L. Spitzer can be reached at spitzer@fas.harvard.edu.