The Paradox of Thrift is sometimes portrayed as a test of the extremes: "when one person saves" versus "when everyone saves".
See, for example, Wikipedia:
In Keynesian macroeconomics, the "paradox of thrift" theory illustrates this fallacy: increasing saving (or "thrift") is obviously good for an individual, since it provides for retirement or a "rainy day," but if everyone saves more, Keynesian economists argue that it may cause a recession by reducing consumer demand.
See also Tom Hickey:
If one person saves instead of spending it is thrift, but if everyone saves instead of spending, aggregate demand craters and recession ensues.
See also Soojae Moon's homework:
When one person saves, that person’s wealth is increased, meaning that he or she can consume more in the future. But when everyone saves, everyone’s income falls, meaning that everyone must consume less today.
See also Krugman in Macroeconomics:
When one person saves, that person's wealth is increased, meaning that he or she can consume more in the future. But when everyone saves, everyone's income falls, meaning that everyone must consume less today.
See also Krugman in Essentials of Economics:
When one person saves, that person's wealth is increased, meaning that he or she can consume more in the future. But when everyone saves, everyone's income falls, meaning that everyone must consume less today.
For a lot more of this, see Google.
The Paradox of Thrift is often expressed as "when one person saves" as against "when everyone saves". This is an example of testing at the logical extremes.
Considering extreme cases is a useful technique. With the Paradox of Thrift, it shows different outcomes at the different extremes. But it only shows the outcomes at the periphery. It misses the central conclusion. In the case of the Paradox of Thrift, it shows different outcomes for "one person" and "everyone". It looks away from the fact that there must be a turning-point somewhere between those extremes.
Considering the effect of increased saving for only "one person" and "everyone" is a simplification. There is a vast distance between "one person" and "everyone".
Surely it is not a problem if two people save?
What if there is one person *not* saving?
Perhaps 17 is the magic number??
There is no magic number. Let me restate the Paradox of Thrift: On a sliding scale of "how much is saved" there is a point beyond which increased saving reduces income, which reduces saving. Beyond that point, saving more becomes self-defeating for everyone because it undermines economic growth (as Tyler Durden acknowledged). The outcome is different on the low side of the turning-point than it is on the high side.
Really, the Paradox of Thrift states that there is a tipping point at which there is a change in outcome even though there is no change in behavior. We save a little more, and our wealth increases. We save a little more, and our wealth increases. We save a little more, and our wealth increases. And then suddenly, we save a little more and our wealth declines.
And for the record, in the case of extreme income disparity it may be possible to have only one person saving, who saves so much that it creates the effect that is said to result when everyone saves.
Some people reject the Paradox of Thrift. Okay. For them, lets consider instead the Paradox of Taxes: On a sliding scale of tax rates, there is a point beyond which increased rates reduce tax revenues. Raising tax rates then becomes self-defeating.
The Paradox of Taxes may be familiar to you as the Laffer Curve. The Laffer Curve says that there is a tipping point at which there is a change in outcome even though there is no change in behavior. Tax rates are raised, and revenues increase. Tax rates are raised, and revenues increase. Then suddenly, tax rates are raised, and revenues fall. The Laffer Limit has been reached.
Come to think of it, the Paradox of Thrift works on a Laffer Curve, too.
"Come to think of it, the Paradox of Thrift works on a Laffer Curve, too."
ReplyDeleteExcellent point, well done.
You're missing a point or two. You call it "no change in behavior," but when more people save (or people save more), it is absolutely a change in behavior on the part of those people who increase their savings.
ReplyDeleteAlso, the paradox of thrift is not a typical economic axiom. It is an example of how things go weird in a liquidity trap at the zero-interest bound. Under normal circumstances, I don't think the paradox exists.
If aggregate demand isn't decreased, thrift will cause no problem at all. And that is the case when the economy is vigorous and expanding.
Cheers!
JzB
jzb: You call it "no change in behavior," but when more people save (or people save more), it is absolutely a change in behavior on the part of those people who increase their savings.
ReplyDeleteI think you miss the point. Suppose I am the only person in the world who saves, and I save only 1% of my income every year (plus the interest on my savings).
If I live long enough, eventually I will own everything. Like the Struldbrugs.
Surely we would be beyond the Laffer Limit at that point.
ReplyDeleteArt,
ReplyDeleteSaving can take many forms. The paradox of thrift applies only to one particular form of saving. If suppose I buy gold, and save gold, the paradox of thrift does not apply, because in today's world, gold is NOT money. It is a commodity.
Paradox of thrift applies only to saving money, and it does not matter if one person saves, or 100% save. The amount of money in circulation reduces by the same amount as the amount of money saved. That small amount of money taken out of circulation will show up as deficit spending by the government. That is the macroeconomic identity. There is no getting around that fact.
From the MMT wiki
Quote:
Flows are derived from the National Accounting relationship between aggregate spending and income. So:
(1) Y = C + I + G + (X – M)
where Y is GDP (income), C is consumption spending, I is investment spending, G is government spending, X is exports and M is imports (so X – M = net exports).
Another perspective on the national income accounting is to note that households can use total income (Y) for the following uses:
(2) Y = C + S + T
where S is total saving and T is total taxation (the other variables are as previously defined).
You than then bring the two perspectives together (because they are both just “views” of Y) to write:
(3) C + S + T = Y = C + I + G + (X – M)
You can then drop the C (common on both sides) and you get:
(4) S + T = I + G + (X – M)
Then you can convert this into the familiar sectoral balances accounting relations which allow us to understand the influence of fiscal policy over private sector indebtedness.
So we can re-arrange Equation (4) to get the accounting identity for the three sectoral balances – private domestic, government budget and external:
(S – I) = (G – T) + (X – M)
The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents.
Another way of saying this is that total private savings (S) is equal to private investment (I) plus the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents.
Ive got to think about this;
ReplyDelete"Suppose I am the only person in the world who saves, and I save only 1% of my income every year (plus the interest on my savings)."
Go back to my thought experiment which starts with everyone consuming all their income ( by need ) which means no disposable income for anyone.
Now one guy figures out how to spend less on food or something so he can now accumulate a savings. This would be just like the "only person in the world who saves" in your example. Whether its 1% or 10% he saves, if he's the only one saving he CANT earn interest. Where will the interest come from? All other income is being consumed. Now, like in my example, he could borrow against his future earnings (if a magic bank appeared) If he was now saving 100$/month and had accumulated 1000$ this magic banker could say "Ill loan you 3000 dollars now and you just have to pay me 75$/ month for the next 5 years"
So really your guy cant earn any interest but he could PAY some!
But forget the loan scenario, just say he saves for 20 years and wants to buy something from one of all the rest who still havent saved a thing because they consume all their income. Now his savings goes to them. He's back to where he started 20 years ago but has something the other guy wanted less than all your guys savings.
Greg,
ReplyDeleteThink of what is happening to the money supply as you save (put the money you earn under your pillow)
Well Clonal there are those who would say that nothing is happening to the supply of money as I store it under my pillow. These are the Austrian quantity theorists and maybe some others. I dont say that my self but it is a view out there. I suspect you are not getting at that but recognizing the lack of spending, the fall in demand that would occur.
ReplyDelete