John Maynard Keynes: The Paradox Of Trift
The paradox of thrift (or paradox of saving) is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees. The paradox states that if everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. The paradox is that total savings may fall, even when individual savings attempt to rise and increases in savings may be harmful to an economy. While individual thrift is generally averred to be good for the economy, the paradox of thrift holds that collective thrift may be bad for the economy (Wikipedia, 2011). The paradox of thrift is
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a central component of Keynesian economics, and has formed part of mainstream economics since the late 1940s, though it is criticized on a number of grounds.
This paradox can be explained by analyzing the place, and impact, of increased savings in an economy.
If a population saves more money (that is the marginal propensity to save increases across all income levels), then total revenues for companies will decline. This decrease in economic growth means fewer salary increases and perhaps downsizing. Eventually the population's total savings will have remained the same or even declined because of lower incomes and a weaker economy. This paradox is based on the proposition, put forth in Keynesian economics, that many economic downturns are demand based.
Keynes himself notes the appearance of the paradox in The Fable of the Bees: or, Private Vices, Publick Benefits (1714) by Bernard Mandeville, the title itself hinting at the paradox, and Keynes citing the passage:
"As this prudent economy, which some people call Saving, is in private families the most certain method to increase an estate, so some imagine that, whether a country be barren or fruitful, the same method if generally pursued (which they think practicable) will have the same effect upon a whole nation, and that, for example, the English might be much richer than they are, if they would be as frugal as some of their neighbors. This, I think, is an
error."
The effect of the paradox of savings is apparent in the savings trends and economic impact in the United States and Japan. Based in the recent declines in the U.S. savings rate, it appears that Americans have stopped saving for a rainy day. Instead, they are living paycheck to paycheck, depending on credit cards to get them through emergencies, and hoping that the rising value of their homes will give them a retirement nest egg (Christian Science Monitor, MSN MoneyCentral, 2011). This personal economic chasm is showing up in the national savings rate, which has been declining for years. The low savings rate is impairing the nation's long-term economic prospects. An improved savings rate would provide investment money for businesses, which would create jobs.
a central component of Keynesian economics, and has formed part of mainstream economics since the late 1940s, though it is criticized on a number of grounds.
This paradox can be explained by analyzing the place, and impact, of increased savings in an economy.
If a population saves more money (that is the marginal propensity to save increases across all income levels), then total revenues for companies will decline. This decrease in economic growth means fewer salary increases and perhaps downsizing. Eventually the population's total savings will have remained the same or even declined because of lower incomes and a weaker economy. This paradox is based on the proposition, put forth in Keynesian economics, that many economic downturns are demand based.
Keynes himself notes the appearance of the paradox in The Fable of the Bees: or, Private Vices, Publick Benefits (1714) by Bernard Mandeville, the title itself hinting at the paradox, and Keynes citing the passage:
"As this prudent economy, which some people call Saving, is in private families the most certain method to increase an estate, so some imagine that, whether a country be barren or fruitful, the same method if generally pursued (which they think practicable) will have the same effect upon a whole nation, and that, for example, the English might be much richer than they are, if they would be as frugal as some of their neighbors. This, I think, is an
error."
The effect of the paradox of savings is apparent in the savings trends and economic impact in the United States and Japan. Based in the recent declines in the U.S. savings rate, it appears that Americans have stopped saving for a rainy day. Instead, they are living paycheck to paycheck, depending on credit cards to get them through emergencies, and hoping that the rising value of their homes will give them a retirement nest egg (Christian Science Monitor, MSN MoneyCentral, 2011). This personal economic chasm is showing up in the national savings rate, which has been declining for years. The low savings rate is impairing the nation's long-term economic prospects. An improved savings rate would provide investment money for businesses, which would create jobs.