Explain how, in the aggregate, increased savings could actually cause the economy to be worse off.?

Question

Why is this called "The Paradox of Thrift"?

Answer 1

i dont know what the paradox of thrift is but i know that according to teh solow growth model teh optimum point of savings is the point at which savings equals investment. the reason for this is that the economy is spending enough today in the form of investment and compensating for it by spending in the future in the form of saving. if the economy saves too much its suffering from dynamic efficiency which means saving exceeds investment and thus the economy could spend more today without sacrificing future spending. if we dont invest enough today what happens is that the economy becomes stiffled and there is no point in saving if you arent consuming that much today to begin with.

Answer 2

Common sense suggests that the more you save, the more you can expect to earn from your savings. However, if everyone saves more, it is possible that there will be a "capital glut"; as more and more money chases the same universe of investment opportunities (some would even argue that the universe of investment opportunities would actually shrink, as more and more income is shifted into saving away from consumption), the economy-wide rate of return will fall, so the economy as a whole will save and invest more, but earn less. Hence, the name, "the paradox of thrift".

Note, however, that in order for that to happen, savings rates must be VERY high and the economy must be relatively large and/or relatively closed. In some Asian economies (Singapore comes to mind), savings rates kept at 30% or more for decades without any visible damage to the economy, simply because savings were invested in export-oriented industries or directly abroad. Given Singapore's small size compared to the rest of the world and its extreme openness to international trade and investment, the paradox of thrift never materialized there...

Answer 3

The American economy is purchase driven. If people save more than they spend then the economy suffers.

By the same token, it is also credit driven and the retail sector is already beginning to feel the pinch from the credit companies new policies and interest rates. Little did congress realize that when the gave the credit card companies permission to charge any interest rate they wanted they were sending the economy into a tailspin.

Contrary to all the "experts" popular beliefs a recession is coming, how big and when? Only time will tell.

Answer 4

When savings increase, purchases decline as the money is going into the bank instead of buying items at the store. Because demand is down, workers can be laid off. Right now, this country is consumer driven to the point that the savings rate is in *negative* numbers - people are spending more than they make and taking the money out of their home equity, previous savings or borrowing to fuel their consumption habits. This isn't good either because if they are laid off, they'll be in trouble. Everyone should have at least six months of living expenses in savings in case of "a rainy day".

Answer 5

There is a "leakage" of money in the economy, when someone saves it removes this currency from the economy, where it cant be dispursed through the circular flow that the economy goes through. this decreases our GDP because for all the money in the economy there is a certain multiplier effect, where at each level more and more is added to the GDP, they calculate this based on the desire for americans to save, percentage vs the desire to spend, known as marginal propensity to save and/or consume.