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PeakTrader said...

The Paradox of Thrift may work the same way as taxes.

In the Paradox of Thrift:

"If everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total savings."

Government (including state and local) raising tax rates, audits, liens, garnishments, fees, fines, fares, etc. will slow economic growth and generate less tax revenues.

Higher taxes force Americans to save even more, and spend less, or default on debt, ceteris paribus.

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Juandos said...

"The Paradox of Thrift..."...

Ahhh, good point PT, yes that is really good point indeed...

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VangelV said...

Not the Foster and Catchings nonsense again. How many times will someone have to point out the error in the Paradox of Thrift before you guys finally figure it out and see reality as it is. Wealth comes from savings, not spending. Before you can spend you have to have the means to produce goods and services in the first place. As Hayek pointed out in the late 1920s, when we save and invest there is more production, more consumption and more profit. The economy does not stay where it was and redistribute the same amount of resources. It actually grows larger and distributes more resources to a population that has been made wealthier by that investment.

People who buy into the paradox of thrift myth simply show their ignorance of the role of capital and interest rates in a complex economy. When a company that makes computers invests in new equipment it can drive costs lower than prices and make more profit from greater sales on more units. Because consumers see a major decrease in prices real wages increase and they are also better off. Savings that increase productive capital create no net loss. That cannot be said about consumption of capital.

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PeakTrader said...

Successful firms strive towards profit-maximization whether or not there's a recession. The capital created is just a measure of success, e.g. producing at $1 and selling at $10 is a 9

Increasing capital investment or expanding production in a recession could be like standing in front of a runaway freight train yelling you're going the wrong way.

When people decide to save instead of spend, firms will lay off workers, and aggregate income will fall, which will cause a further decline in spending and saving will also fall.

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Ron H. said...

Peak,

So, saving is never good? we should always spend as much as we can including borrowing as much as we can to buy even more than we can pay for, otherwise economic activity will enter a death spiral of declining employment, income, spending, and savings until everything grinds to a halt?

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PeakTrader said...

Ron, saving increases with higher income, not higher unemployment, and if borrowing is cheap, then why not borrow?

Higher incomes lead to more spending and more saving.

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VangelV said...

Resources are not 'idle.' Money does not just sit around in mattresses. It gets used by people who want to invest in capital equipment or for some other need. In a free society the appropriate interest rate would be determined by the voluntary transactions in the market.

There is no 'Paradox of Thrift' in the real world. That was a myth that first got a lot of attention in the 1920s when William Trufant Foster and Waddill Catchings began to promote it. It wasn't long until critics pointed out that those who believed in the myth did not understand the role of investment, capital, and interest.

If I do not spend my money and it gets lent out to someone who is building a mine or a factory the money is not idle. It gets spent by the borrower on salaries and materials that are required to complete the project. The money paid to other people or companies gets spend for general personal consumption, salaries, or other inputs that are required to make the products that are used by the investor as part of the project construction. The money simply acts as a medium of exchange for the acquisition of goods and services that are necessary for capital formation. And when the operations begin and increased productivity allows the production of goods and services at lower prices consumers will find that their purchasing power has gone up as have their real wages, even if there is no change in their level of pay.

Go to an American railway station or airport and then compare its state to what you see in most of the world. Your infrastructure is decaying and pales in comparison to what we see even in many developing world nations. Your education system is certainly failing to produce well educated students. Many of your bridges are roads are falling apart. Your power grid is substandard and your power generation capacity is in danger of being unable to supply what is required in many areas. Your sewer and water treatment facilities are getting old and many are incapable of doing the jobs that they are supposed to do.

If you look at growth rates, the US was doing much better when it was a nation of savers and investors. You also need to look to the real economy and stay away from accounting fictions in the financial sector. Most of the 'wealth' created in the past few years was an illusion created by make believe market valuations and improper accounting rules.

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PeakTrader said...

VangelV, when the unemployment rate is 10%, then other inputs, e.g. capital, land, raw materials, energy, etc. are also idle.

Definition of Idle Resources in Economics

"During an economic recession, output drops and unemployment rises, creating idle resources--unemployed workers and unused capital...Idle resources are factors of production--land, labor and capital--not being utilized. Unemployed workers and inactive factories are examples of idle resources...During an economic recession, when production slows and output declines, more resources become idle as unemployment rises, and firms close or curtail production."

If labor can become idle, then other inputs, including capital, can become idle.

Steeper improvements in U.S. living standards have not been an illusion, because GDP doesn't fully capture the gains on both the production and consumption sides of the economy.

There's a difference between the rise in living standards in the private sector, e.g. in the U.S., and the rise in living standards through the public (or state) sector, e.g. in China. There is a different mix of goods.

It seems, many underestimate the market power of many U.S. goods in the global economy, and how desperate some U.S. trading partners are in maintaining their employment levels, which both benefit the U.S. enormously.

Anyway, you haven't disproven the Paradox of Thrift, either mathematically or empirically.

Firms will not ramp-up investment and lower prices to induce demand (there's also the concept of "sticky prices") when people decide to save instead of spend:

U.S. GDP falls 1 percent in second quarter as recession eases
08/27/09

"Domestic investment fell 24 percent -- a large amount, but one that also further confirms an recession bottom, because domestic investment plunged 50 percent in the first quarter.

In addition, the 'frugal consumer' trend continued: the U.S. savings rate increased to five percent."

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Ron H. said...

Peak,

As you must be aware, Hayek pointed out the errors in the work of Foster and Catchings.

From the Robert Blumen article:

"Hayek criticized Foster and Catchings: "What they entirely lack is any understanding of the function of capital and interest."[8] By analyzing the effect of savings on the structure of capital in the economy, Hayek showed that the new investment would enable firms to reduce their production costs by more than the amount that prices would fall, enabling firms to make profits at the lower prices. And real wages would rise, providing the "missing" purchasing power.

The two authors showed only that more workers can produce more goods with the same amount of capital per worker. But as Hayek explained, the real question (and one they could not answer) is, how can the same workers produce more goods? The answer is that the amount of capital per worker must increase. Increased capital in proportion to labor is the only means of producing more without the number of workers increasing."

"Hayek demonstrated that the Foster and Catchings' underconsumption doomsday does not arise. The "missing" purchasing power comes from the increase in the supply of goods that workers are able to produce. As they supply more they are able to demand more. Rather than a collapse into depression, the entire system reaches a new equilibrium at a higher level of savings by means of adjustments everywhere else: in labor and in capital; in prices and in quantities; in production and in consumption."

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PeakTrader said...

Ron, I've never disputed investment can lower production costs, increase the quantity and quality of goods (to raise living standards) and increase profits. That's normally the case. The Paradox of Thrift, like the Liquidity Trap (and expansions taking place more often than contractions) are rare cases.

Japan Battles the Paradox of Thrift
July 2000

"The key to understanding the fundamental problem facing the Japanese economy can be found in the Keynesian notion of the paradox of thrift.

For nations, as opposed to individuals, the parallel to the paradox of thrift is the mercantilist doctrine. If a nation restricts consumption in order to run a balance-of-payments surplus and accumulate gold, the shortage of demand depresses output, prices, and employment and leaves the nation worse off.

By the late eighteenth century it was recognized by David Hume and others that the accumulation of gold should be allowed to increase the money supply and thereby propel spending on domestic and foreign goods so that prices and output rise and the economy is revived.

The idea that thrift is at all times a virtue either for individuals or for nations has never really died, although it was intellectually vanquished for nations by the free-trade doctrines that grew up in England in the later eighteenth and early nineteenth centuries and, one would have thought, for individuals by Keynes in The General Theory of Employment, Interest, and Money.

The Fable of the Bees sets forth the problem encountered by a prosperous community in which all the citizens suddenly decide to abandon luxurious living...in the interest of more saving. Mandeville concludes his allegorical poem the Fable of the Bees as follows:

Bare virtue can’t make Nations live
In Splendor. They that would revive
A Golden Age, must be free,
For acorns as for honesty.

The tragedy of the economic picture unfolding in Japan is more profound than that suggested by Mandeville in the Fable of the Bees. Japanese households are not arbitrarily deciding to be more thrifty in order to increase future wealth. Rather, they are driven by absolute liquidity preference and risk aversion either to hold cash or to hold short-term government securities."

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