Is your saving more money hurting the overall macro economy? It is called the Paradox of Thrift. Well a number of economists have debated this question more intensely for the past 15 months. Below is an article I found on Consumerism Commentary. I feel the author explains the argument pretty well from both sides.
The Paradox of The Paradox of Thrift
By Flexo on Monday, February 16, 2009 in Saving
If you’ve been paying attention lately, you might have heard that throughout the economic recession, Americans have been saving more of their income. Some economists worry that saving, while good for the individual, can be harmful to the economy as a whole. This is commonly called, “the paradox of thrift,” a theory developed by John Maynard Keynes, a popular economist who in the early 20th century saw spending as the basis of an economy.
Keynes looks at a recession as a vicious cycle, illustrated here:
In this model, it is theorized that saving more money can eventually result in having less money to save on an aggregate level. The only thing that can break this cycle is something external. In our case, it is the government. The first treatment was “stimulus,” payments given to taxpayers (from current or future tax receipts) to help “stimulate” the economy.
The reaction, when this didn’t work, was that this wasn’t enough to break the cycle, and more stimulus was needed to noticeably affect the economy. The government decided to go directly to businesses, providing them with the capital needed to finance shovel-ready projects, hire more employees, and keep aggregate income up so consumers would feel that their money is better spent, spent.
The easiest argument against the validity of the paradox of thrift is that, for the most part, there is no such thing as saving money. Money is either spent now or it is spent later. Another possibility is that it is invested now and transferred to a business, and the business either spends it now or spends it later. When you decide to spend money later, in almost all cases, you put the money into a bank account, which provides the bank with more funds with which to provide loans to businesses now.
As long as banks to continue to loan out money, the economy doesn’t decline. But as we see now, thanks to the “credit crunch” (which we haven’t been hearing about as much recently), that’s not happening.
In short, it’s not consumer spending or saving, but the financial industry’s refusal to lend money to credit-worthy businesses that is keeping us amidst the recession.
The paradox of thrift, the idea that saving more money was bad for the economy, was invented when personal rates of saving were much higher and consumer credit was all but nonexistent. At this time in American history, “saving money” meant keeping cash under a mattress outside of the banking system. Perhaps the paradox of thrift was a reality at that time, but despite its popularity in the news recently, it probably no longer applies to America’s modern economy. Many economists now agree that this aspect of Keynesian economics has seen better days.
Does the government need to step in to break the cycle, like Keynes suggested? Probably, but it needs to take the right actions. Helping tax payers with $400 over two years is not enough because it doesn’t have a large enough effect for the majority of Americans in order to restore consumer confidence.
The economy is broken at the lending level, and that’s where the government should focus. Banks need to lend money to credit-worthy customers. If they refuse, the government can step in, and they have a number of options, with approaches ranging from near-socialism to capitalism, including:
Continue to save money and spend less than you earn. It’s not a patriotic duty to spend it on products and services you don’t need, despite what you might hear. There is no need to sacrifice your future financial well-being for the sake of the greater good. It wouldn’t work, anyway. The economy will be sorted out with or without the house you buy now rather than a year from now.