paradox of thrift?

silverharp

Agree or disagree?


Why there is no "paradox of thrift"

The "paradox of thrift" holds that what is good on an individual basis can be bad on an economy-wide basis; specifically, it stems from the idea that an increase in an individual's savings may benefit that individual, but if many individuals increase their savings then the result will be a weaker economy.

The idea that what's healthy on an individual basis can be unhealthy on an economy-wide basis doesn't make sense because the economy is just a large collection of individuals, each of whom acts to increase his/her own satisfaction. However, it is firmly fixed in the minds of many economists and commentators because they make the false assumption that economic growth is driven by consumption. If you believe that consumption-related spending is the driver of economic growth then you will naturally view an economy-wide increase in current savings -- and a concomitant reduction in current consumption -- as a threat.

The method by which GDP numbers are concocted helps to entrench the mistaken notion that consumption drives growth, but consumption-related spending is actually at the END of a chain that begins with saving. An increase in saving supports an increase in capital investment, which, in turn, paves the way for an increase in production and, lastly, an increase in consumption. Putting it another way, before you can get a SUSTAINABLE increase in consumption-related spending you need an increase in production, but more production generally requires more investment in capital equipment and technology, which, in turn, requires more saving. That is, rather than being a threat to economic growth an economy-wide increase in saving is the necessary first step in the growth process. There is no "paradox of thrift".

Governments routinely try to get around the need for production to precede consumption. They do this by, for example, ramping up the supply of money in an attempt to encourage more spending. Inflationary policies (policies that result in more money sloshing around the economy) can, for a while, create the ILLUSION that savings have increased and that the economy is growing rapidly, but such policies ultimately lead to very bad economic outcomes -- as we are currently seeing -- because they lead to real savings being used up in business ventures and other investments that are not fundamentally sound.

The crux of the current economic malaise is that mal-investment on a grand scale over many years depleted the pool of real savings. Consequently, recovering from this situation requires the accumulation of savings -- on an individual-by-individual basis and an economy-wide basis. An increase in savings will lay the foundations for an eventual strong and sustainable recovery, whereas policies that discourage saving will act to prolong the agony.

Additional information on this topic can be found in the below-linked articles:

http://mises.org/story/2804
http://mises.org/story/3064

10000maniacs

Good point(s) silverharp.
When you apply your theory to our current economic climate, the government are actively discouraging saving by ensuring that you will need an interest rate of 8% to make any real yearly gain on your savings. (Increasing DIRT to 23%)
Therefore they want us to go out and spend our spare cash instead of saving it. Thus kick-starting the economy. But obviously this will mean less capital available to the banks and therefore less money to lend to small businesses, thus crippling the economy.
Which is the greater of the two evils?

silverharp

10000maniacs wrote: »

Therefore they want us to go out and spend our spare cash instead of saving it. Thus kick-starting the economy. But obviously this will mean less capital available to the banks and therefore less money to lend to small businesses, thus crippling the economy.
Which is the greater of the two evils?

do you remember Bush told americans to go out and buy SUV's after 911 for the sake of the economy. :rolleyes:

There is too much debt in the system and it needs to be paid of/defaulted on before a new cycle can start. The only question is how much this process will be dragged out by misguided central bank and gov. policies to "expand" the economy.



you might enjoy this , an interview with that clown Art Laffer from Aug 06, I couldnt stop laughing
http://www.youtube.com/watch?v=LfascZSTU4o

Drag00n79

Here's Laffer on the Bill Maher Show a couple of weeks back. Train wreck of an interview.

https://www.youtube.com/watch?v=z3WjgKUf-kA

superhooper

Interesting stuff Silver. Does the 2009 budget reflect this theory by really reducing the government spend in the economy? Also does anyone know to what level is the Irish Economy is consumer driven?

silverharp

superhooper wrote: »

Interesting stuff Silver. Does the 2009 budget reflect this theory by really reducing the government spend in the economy?

I don't know, I didnt follow the budget but I'd be interested to see how quickly they will adjust spending down if revenue drops more then they "hope" for, my guess is that will borrow more using the excuse that it is a short term overrun to "support" growth or that everyone else is doing it.