The "paradox of thrift" and fiscal stimulus

“The "paradox of thrift," a celebrated chestnut first described by John Maynard Keynes in the 1930s, has been the source of much confusion about how saving affects the health of the economy. Intuition suggests, correctly, that if any one family saves an extra $100 this year, its bank balance at year's end will be higher by that amount. According to the paradox of thrift, however, if everyone tries to save more at once, total savings will actually fall. ....

At moments like these [economic recession], government is the only actor with both the motivation and the ability to jump-start the economy.

Passage of a robust stimulus bill has rightly been the Obama administration's highest priority since taking office last month. As Keynes explained during the Great Depression, increased public spending would help end the downturn even if it were for useless activities like digging holes and filling them back up. It would obviously be better if the extra spending went for something useful. And as it happens, decades of infrastructure neglect, combined with huge state and local government budget shortfalls, provide more than enough valuable projects to put everyone back to work.

Bizarrely, however, some Congressional critics have denounced the administration's stimulus proposals as "mere spending programs." Of course they're spending programs! More spending is exactly what we need. The imperative is to get this legislation passed and get the spending started right away. ....

The "paradox of thrift" applies only during economic downturns .... Most of the time ... the economy operates near full employment. Before long, it will again. Under those circumstances, if every family saved a little more, extra money would flow into the capital market, causing interest rates to fall and investment spending to rise.”

Robert H. Frank, "Economic View: Go Ahead and Save. Let the Government Spend.", New York Times (15 February 2009).

http://www.nytimes.com/2009/02/15/business/economy/15view.html

[DOW: Cornell economist Robert H. Frank is currently a visiting professor at New York University's Stern School of Business.

Yes, the “paradox of thrift” exists, and with households attempting to save more than in the past government expenditures can counter the deflationary effects of this increased saving by injecting spending into the economy. But so would an increase in private investment expenditures, maybe not completely, but with some impact. Yet nothing was done in the recent stimulus package to encourage
investment.

Further, the assumption by Frank is that the stimulus package will have its intended multiplier effects. The contention of critics of the package is that it will not work and will only increase the national debt.

Time will tell whether the boosters or the critics of the stimulus package are right.

Once again, thanks to Larry Willmore for the Tdj.