Paradox of Thrift

Hard-Hit Families Finally Start Saving, Aggravating Nation’s Economic Woes.

Herman Ridder Junior High School

That was the headline of The Wall Street Journal about a year ago. The self-contradictory headline is by far the best example of paradox of thrift that you will ever come across. During this period, several other magazines and dailies had similar sounding headlines to their credit; all of which stated that our tendency of saving money during economic slowdown, is coming hard on the overall economy of the nation as well as the world.

John M. Keynes and the Paradox of Thrift

Even though it is difficult to trace the exact origin of this concept, with some sources tracing its application to antiquity, the credit of popularizing it in the modern era goes to eminent English economist, John Maynard Keynes. An ardent advocate of the use of government monetary and fiscal policy to maintain full employment without inflation, Keynes voiced the need of spending instead of saving for economic stabilization way back in 1931―when the Great Depression was at our doorstep. Keynes himself cited the first instance of the use of this concept in a 1714 book titled ‘The Fable of the Bees’ authored by philosopher-economist, Bernard Mandeville. In Keynesian economics, the paradox of thrift has a crucial role to play, considering that this economic school of thought is of the opinion that demand is one of the driving factors when it comes to economic downturns.

The ‘Paradox’ Explained

In economics, the paradox of thrift is a paradox (a statement that contradicts itself), which states that if all of us try to save money during an economic recession, the aggregate demand will fall, and this decrease in consumption and economic growth will eventually lower the total savings in the overall economy. In a broad sense, it suggests that saving―a practice which is beneficial for you as an individual―is harmful for the economy as a whole.

During an economic recession, people try to save as much money as they can in order to secure their future. Instead of being helpful, this adversely affects the economy. Simply put, if the consumer does not spend, it tends to result in decline in overall revenue earned by the companies―a decline which may eventually force the companies to cut down on pay or―in worst case scenario―resort to layoffs. It takes on the widely believed idea that saving is good for the economy, by stressing on the fact that even though individual saving may seem good for the economy, collectively it hampers economic growth and results in more economic problems in the society.

Criticisms

Though this concept seems quite practical in nature, it has been subjected to a great deal of criticism by some of the famous economists of the world. Some of these economists dismiss it citing that the prices will fall during a recession, and this fall in prices will result in an increase in demand and bring things back to normal. Others argue that savings being loanable funds, tend to increase institutional lending and subsequent spending. Some economists also argue that saving money is better than hoarding currency, which can eventually result in savings-induced recession.

Though the critics have always been of the opinion that the paradox of thrift is a theory and not a stated fact, you don’t need a degree in economics to see that today this ‘theory’ is applicable to the US economy like never before.