Case in point: the paradox of thrift. Basically this idea states that:
If everyone saves 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.In simple English, this means that if everyone saves during a recession, then consumption will go down and economic growth will stagnate or fall.
Now, I do not have an economics degree, nor did I take any formal economic courses in high school or college. I’ve read a few books and articles written by prominent economists, but that is about it. Given my lack of an educational background in economics, I am still fairly confident I can deconstruct the theory using only simple common sense.
First of all, this paradox is purely theoretical. I’m sure that Keynes made that point in his various published media because in all practicality, such a feat is impossible in a free society. So it while it makes sense in theory, it will never happen in reality. At any given time, people are spending, saving, or giving with their money in some fashion or another. It does not matter what state the economy is in. You will buy things, whether you need it or not, because that is how humans interact in the marketplace and because of your own rational self-interest.
Secondly, the paradox theory itself seems to be very shortsighted and limited in perspective. The premise assumes that people are simply saving money as a means to insure themselves from the future. It does not factor in other personal finance issues, such as debt. If you are living more thrifty today than you were during good economic times, this is more likely due to the fact that you have a lot of debt to clear up. For the past two and a half years, my wife and I have limited our spending and saving in order to pay off our debts. In essence, thrift does not necessarily mean that people are hoarding or saving money.
Thirdly, it assumes that savings increases through economic growth. I am assuming that Keynes meant the interest rate on savings would decrease because the economy is contracting during a recession. At face value, this is true, but only until you address the source of the interest rates. If the interest comes directly from a bank through savings account, then it is based on the what the Federal Reserve does with its own base interest rate, at least in the United States. Therefore, saving has nothing to do with economic growth, but the whim of the Federal Reserve.
Saving does get tied directly to economic growth only through long-term investing products, such as mutual funds, stocks, and bonds. If such saving goes up during a recession, would that not mean people are confident in the economic future of a country? So while the theory may hold weight with this kind of saving, it breaks down when you consider that long-term investing is a good sign of consumer confidence.
Lastly, this theory assumes that people will always save until they die and that people will not take out portions of that savings to buy things. Once a huge portion of the populace is out of debt and has a sizable amount of savings, I am sure that consumer spending will go up again. And whatever savings they do not remove will grow much more once the economy gets rolling again.
So Keynes did not know what he was talking about when it comes to the relationships between thrift, savings, and economic growth. The only reason such theories have any credibility these days is largely because of the late President Franklin Delano Roosevelt and his “New Deal.” Both former President Bush and President Obama rely on this economic model to dictate government policy.
Already, however, many people are beginning to see the fallacy of Keynesian economics. It really does not take much effort to demonstrate how foolish it is to utilize Keynesian economics to dictate government policy, as shown here.