When you save your money instead of spending it, you are actually hurting the economy in a small way. It may seem counterintuitive that your savings are adding to our economy’s decline, but they are. Most of us have come to embrace globalism and our intertwining financial lives, but we often fail to realize that saving our money actually has far-reaching, unintended consequences.
Most consider increasing the amount of money you save to be a positive financial attribute, but it can actually work against the greater good when it happens across the board. Economists call this the Paradox of Thrift.
Spend, save, or invest
When you earn money, there are three basic things that you can do with it. You can either spend it, save it, or invest it. With the American economy treading water, the nation’s savings rate has been steadily creeping up. Historically, Americans have not saved or invested much of their paychecks. In fact, the savings rate in America has typically hovered around 1% of a person’s take home pay.
But with today’s economy struggling and unemployment high, the nation’s savings rate has recently risen to 5-6%. With people saving more money from each of their paychecks, less is being spent on consumer goods. While an increased savings rate is typically seen as a positive financial trait, it can create unintended problems.
What is the Paradox Of Thrift?
In the early 20th century, the famous economist John Maynard Keynes wrote about what he called the Paradox of Thrift which ultimately states that saving more money instead of spending it can exacerbate a troubled economy like the one we currently find ourselves in. Consumer spending drives 70% of the American economy. If more people are saving and investing their money instead of spending it at our nation’s malls and other retailers, the entire economy suffers.
This can turn into a vicious, self-perpetuating cycle. More savings results in less spending. Less spending on consumer goods reduces the revenues that American companies earn. When companies’ earnings decrease, they typically lay off workers. When workers lose their jobs, they tend to tighten their belts and try to save more money — though they might actually have less to save (or spend) at this point.
In other words… Saving money and being thrifty results in less spending, fewer jobs, a declining economy, and an aggregate decrease in savings. Quite the paradox.
What should you do with your money?
Given the above, what should you be doing with your own money in the current economy? In my view, even with interest rates at all-time lows, you should continue saving and investing for your future and your financial goals. Honestly, even a 6% savings rate isn’t good enough. Many financial planners encourage people to save 10% or more for retirement alone — and that doesn’t include other financial goals such as buying a new home or helping your children pay for college.
Why you shouldn’t care about the Paradox Of Thrift
Your money — and what you choose to do with it — is just a small part of the economy. In the grand scheme of things, it really doesn’t matter what any one person does with their money. It only matters what we all do as a collective group. Should large-scale, macroeconomic factors such as this dictate what we do as individuals? Should second and third order effects bother us if we are looking out for our own wellbeing? Not in my book.
So… Do you feel bad about hurting the economy when you stash some money in your savings account or buy a CD? Bad enough to go out and start spending? More generally, do you believe in the Paradox of Thrift — that saving more of your money contributes to an overall economic decline?
16 Responses to “The Paradox of Thrift”
Macroeconomics (of which Keynes was a celebrated practitioner) should be never be given more credit than the “dismal science.” The set of ideas that macroeconomists agree upon is vanishingly small and the paradox of thrift is not one of them. Keynes, or his current day supporters, will not be providing you with a comfortable and secure retirement after you fulfill your macroeconomic duty to consume today.
| BG says: “If everyone decided to save and not consume, then everyone would be fired because companies don’t employee people when there is no demand for its products… ” |
There is ALWAYS demand.
People can no more stop ‘consuming’ then they can stop eating & breathing.
Most people spend most of their wage earnings every month… many spend (consume) all of it, and some spend even more than that (thru credit/loans).
All human labor is aimed at consumption, either present or future.
Companies & employees meeting consumer demand will ALWAYS be able to profitably sell their products in a free market. Of course, companies who operate inefficiently and/or waste resources on things with low or no consumer-demand will fail… as they should.
Human needs & wants are unlimited, but labor & capital are always scarce in producing the goods/services to meet those objectives. The general economy and standard-of-living can NOT improve without efficient use of available labor…and the accumulation of capital.
Monetary savings are capital (deferred consumption) — invested savings are GOOD because they enable more production for eventual human consumption.
Berelston) Your conclusion doesn’t make sense. If everyone decided to save and not consume, then everyone would be fired because companies don’t employee people when there is no demand for its products.
You think companies will just fill warehouses with products that won’t sell?
You want to argue which came first: chicken or the egg; when we have a disease that is killing all eggs.
Its a deflationary spiral, same as Japan has been in for a long time now; and I don’t think we can avoid it. The only cure is time, and a lot of it, until old debts are repaid.
“If you stuff your mattress with most of your monthly wage$ … you benefit others and possibly hurt only yourself.” Sure, if one person (or a few people) do it. But when you reduce consumer demand en masse (large numbers of people cutting consumption) businesses also respond by reducing production. Prices will only be driven down so far by lower demand before supply is corrected to compensate – resulting in fewer people employed to make goods or provide services, which then further lowers demand because they don’t have money to spend…
Just more Keynesian nonsense.
If you stuff your mattress with most of your monthly wage$ — you benefit others and possibly hurt only yourself.
Your money wages are merely tokens you get ‘after’ you have already contributed your labor to the general economy in producing goods/services for others to consume… when they trade in their tokens (wages) to buy stuff.
If you don’t use your tokens (wages) to buy stuff or invest– you are simply declining to take your earned share of stuff from the general economy. Thus, there’s bit more for everybody else at lower prices — since you reduced consumer ‘demand’ for existing goods/services.
It’s kinda like buying a winning lottery-ticket, but refusing to cash it in…. nobody else is harmed. Others are actually helped… the pot is bigger in the next lottery round — because you chose to leave your just winnings/earnings for others.
Keynes was wrong on everything — except long-run-death.
“I think that it is important to recognize that what is best for the individual may not be best for the economy as a whole.”
And this is why microeconomic principles do not apply to macroeconomics. On a different blog someone was saying that he saves 40% of his income (which is awesome) and how the economy would be so much better off if everyone did the same – I couldn’t convince him that a contraction in consumer spending of that magnitude would be disastrous for the overall economy.
Savings doesn’t necessarily have to come in the form of a savings account. There are many who are paying off and swearing off debt. This means that the money supply contracts as debts get eliminated. Banks are not extending additional credit and companies are hoarding cash as well.
I agree with Kevin. I don’t agree at all with this “When you save your money instead of spending it, you are actually hurting the economy in a small way” unless maybe you have your money in a mattress. If the money is in the bank, the bank is using that money to lend to others, who are spending it. so i’m making profit (albeit small), the banks are making a profit, the borrower is gaining something from it, and who ever the borrower bought something from is profiting.
And while I see Keynes point, i don’t think the economy should be based on crazy spending. it’s not stable, so yeah, while it may hurt this current economy, a better one can spring up in it’s stead. Our economy shouldn’t be based on people spending beyond their means. it’s not sustainable
Dan) that is the tragedy of the commons.
I think save/invest, and buy local is the best thing for our economy.
I think that it is important to recognize that what is best for the individual may not be best for the economy as a whole.
Kevin: Good catch. Fixed it.
F. A. Hayek would agree, you should spend principally on needs (shelter, food, clothing), save, and don’t spend too much of your capital chasing returns because speculation (real estate, commodities, equities) fuels market bubbles.
For a sweet synopsis on modern macroeconomics debate, check out some cool videos here: http://www.econstories.tv
Actually, there are two other things that we can do with our money. We can pay down debt or we can give it away.
I was thinking about these things back when we were getting a tax rebate. We were urged to spend it. I was wondering then, as I do now, why any of the other things don’t help the economy. If I save it or pay debt, the bank can loan it. If I invest it, businesses can buy equipment or hire employees. If I give it away, the charity or individual will spend it. So it gets into the economy regardless of what I do with it, unless I bury it in the back yard.
Hank, I wasn’t sure where you were going with this article, but I liked that you took the savings route over the liberal “spend money to boost the economy” route. I wish things were different, but all you can do is protect yourself in this economy, as many Americans are in pure survival mode.
We cut back on restaurants/travel/entertainment first, then other shopping after that. Unlike the first commentor, I actually think the TV bill is one of the most thrifty forms of entertainment. I’d much rather spend $100/month on TV than $50 for a 2-hour long movie (for a family of 3) that is probably going to suck. TV at least allows endless entertainment and a seemingly endless amount of choices. Good luck!
John Maynard Keynes is a 20th century writer, not 18th.
Other than that, I’d fully concur. The Paradox of thrift might have some weight if we hide our money in a mattress, somewhat with hording in precious metals [not quite as that would stimulate the mining, refining & recycling industries]. However, most people in the US either place their “thrift” into a bank, thus increasing the “loanable funds” for the economy, or invest directly via stocks or bonds, also providing capital to the economy.
My name is John, and I’m addicted to “Shiny”. I’ve considered the negative effect of an overall increased savings rate but never knew about the term. My savings rate is better than most, especially if you consider debt reduction as savings.
The economy is struggling right now to support American’s perceived need for “shiny”. How many people do you know that appear to be on the edge of financial disaster from day to day, yet their smartphone and cable TV bills are the first thing on the list to get paid off? There is a happy balance, and I think we are getting closer to it right now despite the short term effects. If more people have a little savings to fall back on, they won’t require expensive rescue efforts.