I’ve been saving more during the past recession.. 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 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:
· Less money is being spent by consumers.
· Demand for products and services decreases.
· Businesses reduce production and eliminate jobs to meet demand.
· Unemployment increases, resulting in less income for saving or spending.
· Rinse and repeat.
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 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.
But the argument is, When people save, they don’t spend. Above argument stated that it is OK… because the bank will have deposits to lend … but what a business needs is revenue.. not loans… Most businesses have a lot of loans already because businesses are financed by loans. They need revenue to pay the interest, and other expenses. Given poor revenues, a business can’t usually get more loans to survive simply because it can’t pay it’s bills.
A business is the same as a person. You wouldn’t say that if a person has a low-paying job then that person should finance a high-flying lifestyle on credit cards. You would say that the person should reduce the lifestyle. For a business, this means reducing expenses which usually means lay-offs or closure.
The economy is definitely not broken at the lending level, except due to the crazy mortgages that originally started this. Banks do not lend even to each other because they no longer know the risks of the loans and they have to ensure that they have enough money themselves to remain solvent. Assets are worth much less now and risks are much higher. In those situations there is simply no money to lend, not that the bank is refusing to lend…
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