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Many Austrian/Neoclassical websites argue that Keynes and Keynesians demonise saving and encourage individual people to spend rather than save. Someone (not an economist) recently told me that I need to feel guilty for my frugal lifestyle and that I'm being unpatriotic and should spend more money to help the economy. But I'm not convinced that this is what Keyensians actually believe, as opposed to a straw-man used by the anti-Keynesians. I thought the point was not that it's damaging to the economy for individual people to save their money as aggressively as they want to, but rather that if there is a paradox-of-thrift type situation during a recession, the government should take corrective action to reflate the economy. And I also thought that Keyensians believed that a higher household savings rate is always good in the long run, and that the debate was specifically about what happens during a recession.

Is my friend right or am I? Is it really true that there is any significant school of economists who would think that individual people saving their money prudently was bad for the economy and that such people ought to feel guilty for being savers? Or can I carry on saving aggressively guilt-free?

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  • $\begingroup$ Economists do not usually talk about "guilt" or the "need to feel guilty". $\endgroup$ – Kenny LJ Nov 11 at 6:39
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    $\begingroup$ @KennyLJ I know. But my question is not so much about whether this non-economist's moral philosophy is correct, so much as whether their understanding of Keynesian economics is. I don't think it's true that Keynes or his acolytes disputed that household saving was, in the long run and the general case, good for economic growth. That's my question - are they right (about their understanding of Keynesian macroeconomics) or am I? $\endgroup$ – Statsanalyst Nov 11 at 20:51
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I like the analogy of money as a vote on the allocation of resources (land, labour, enterprise, and capital). When you purchase a lot of onions at a grocery store, you boost the demand for onions and thus put more of the world's resources on the production of onions. By not purchasing anything, you're effectively voting "abstain" and allowing the rest of the world to dictate how resources are used. Note that you will never truly be voting "abstain" as your savings are now in the hands of bankers, or whomever is controlling your money, to reallocate.

The issue is that sometimes resources aren't fully allocated and some of the symptoms are low inflation and high unemployment. Ideally the government would step in and make good use of unallocated resources (e.g., fix broken infrastructure). Unfortunately, for political reasons this may not happen in which case central banks may step in to try to artificially allocate resources through policies such as quantitative easing.

So I would frame the question as follows: assuming you believe resources aren't being fully allocated in your economy, is the money you're about to spend going to result in a better utility for you (including the utility you receive from believing your country will be better or worse off) than if other people or the government (or central bank) came in to fill that void? The worst thing you can do is spend money on goods and services you don't need and believe other people won't need more of: this gives you little utility and it also gives the economy the illusion that whatever good or service you consumed is in demand, and thus allocates more resources on producing that good or service. Since it sounds like you're happy with your own life, it may be worth considering putting money towards things that you believe other people might benefit from. Note this doesn't necessarily have to be personal consumption: you can donate or invest in clean energy, local organizations, or whatever you believe there should be more of in society.

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Keynesians likely don't worry about household savings being too high, especially in an environment in which households face a soft cap on nominal income and so must spend a rising proportion of their real income to survive. In stable(ish) times, household savings become, one way or another, investment by businesses. If that investment does not materialize into growth, it would be classified as malinvestment, not malsavings. I believe you understand Keynes' point accurately - the "paradox of thrift" describes a situation where I am saving to ration, not saving to invest. This is a very different kind of "saving".

Corporations are not so constrained in income, and are the main locus of concern (or should be) for hoarding activities. Apple is the quintessential example, reporting \$245B in cash on hand for Q1 2019. This is not truly "saving", as it does not translate through any kind of accounting identity into investment. And its scale is such that there is real worry it can produce frictions in the economy - US money supply (M1) was $3.7T in January of this year -- Apple is sitting on 6.6% of that. If you believe in the quantity theory of money, that's going to have some impact on prices, output, or both.

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The issue is more complex than your friend suggest and he is not completely right but at the same time there is a kernel of truth to what he is claiming. There are differences in the effect of savings short and medium and long run. However, to fully explain this I will have to use some math to ground the reasoning and make everything consistent.

Consider simple closed economy. By definition in any closed economy the total output/income $Y$ must be equal to consumption $C$, investment $I$ and government spending $G$. This is just accounting and will always hold so we have:

$$Y = C+I+G$$

Now we know from basic economics that consumption must be some positive function of disposable income $C=C(Y_d)$ with $C'>0$. This is just common sense if you have more money avaiable you will consume more goods and services in general. This is consequence of the basic non-satiation assumption - more is always better on which most economics builds on. To make things simple let us assume that the relationship is linear so we have:

$$C=c_0 + c_1Y_d$$

where $c_0$ is some basic consumption that you have to undergo irrespective of income to just stay alive and $c_1$ the marginal propensity to consume, i.e. the share of income you use for consumption as opposed to saving. Now by definition disposable income is the income after taxes $Y_d = Y-T$. So in fact our consumption function turns into:

$$C= c_0 + c_1 (Y-T)$$

Second we will hold investment constant which reasonably holds in the short run (but not necessary in the medium long run) as most investments are not very liquid so we have $I= \bar{I}$. Government spending will be treated as completely exogenous (determined outside this model) so it stays $G$.

Now to solve this model we can just substitute consumption function $C$ into the first equation which gives us:

$$Y = c_0 + c_1 (Y-T)+\bar{I}+G$$

Now solving for $Y$ using basic algebra we get the following:

$$Y = \frac{1}{1-c_1} \left(c_0 +\bar{I}+G-c_1T\right)$$

Now this last equation is all you need to understand the paradox of thrift. First consider the second part of the equation $\left(c_0 +\bar{I}+G-c_1T\right)$. This part is called autonomous spending because it does not depend on income as $c_0$ is basic consumption of necessities $\bar{I}$ is fixed investment and $G$ and $T$ is government spending and taxation which is exogenously given so in this model it wont change.

So now you must be wondering where is the effect of saving on income? Well it hides in the first term:

$$\frac{1}{1-c_1} $$

recall $c_1$ is the share of income you spend on consumption - since you can only consume or save $(1-c_1)$ is the share of income saved.

Now its trivial to see that as $(1-c_1)$ increases the $Y$ must fall holding everything else constant. So your friend is definitely right that in the short-run saving more - meaning saving larger proportion of your income not just saving more in dollar terms - leads to lower income.

However, here we set investment constant, which is reasonable in the short run, but not in the long run. Just as a matter of accounting identity the investment must be equal private $S$ and public $T-G$ savings so we have:

$$I=S +T-G$$

So increasing saving also increases income. Furthermore, saving is also necessary for economic growth. The reason for this is that economic output depends on factors of production like capital and labor. For simplicity lets focus just on capital. We know that the more capital economy has the more it can produce so we know that $Y = F(K)$ with $Y'_k>0$. So the national income increases with amount of capital avaiable.

Now how do you get more capital? By saving! Again just by pure accounting identity the stock of capital tomorrow $K_{t+1}$ must be equal to capital today net of depreciation plus investment:

$$K_{t+1} = (1-\delta)K_t + I_t$$

We already know $I=S+T-G$ lets set taxes equal to gov. spending to simplify we get $I=S$. Now going back to the original equation on consumption since $c_1$ is marginal propensity to consume $1-c_1$ must be marginal propensity to save so we can replace $I$ by savings which are $S=(1-c_1)Y$ to get

$$K_{t+1} = (1-\delta)K_t + (1-c_1)Y$$

So in the long run you get more capital accumulation and economic growth when propensity to consume $c_1$ is small or consequently when share of income saved $1-c_1$ is large. So your friend is definitely not correct if he claims that being thrifty is always bad for the economy or that (New) Keynesians claim that.

PS: This was not part of your question but note that while some pundits still use words like Neoclassical and Keynesian as synonyms for free market pro saving economists and pro more government regulation spending economists respectively, this distinctions no longer hold. The current mainstream in economics is Neoclassical synthesis which is combination of Neoclassical micro models and Keynesian macro models as well as some other ideas. So nowadays words like Keynesian or Neoclassical dont carry the same meaning. For example, Mankiw is a New Keynesian but he is small government, pro saving, conservative/libertarian while Stiglitz work is neoclassical and he is pro big government, pro spending, liberal. The reason for this is that both the neoclassical and keynesian models are highly nuanced and the pro-spending vs pro-saving debate depends heavily not just on science but also on personal values, the ways how a person discounts future benefits of economic growth and all this discussion gets more complex once you include inequality and philosophical discussions around that.

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