The paradox of thrift

Really good article explaining how recessions work and why tax cuts and “letting people keep more of their own money” may sound nice, but doesn’t actually help anything.

Now we’ve entered “paradox of thrift” territory. People are saving more. And the increased saving isn’t being cycled back into the economy as new investment. In part, that’s because of problems in the financial system. But in part, it’s because with short-term demand slumping so much, there’s not a lot of worthwhile investing to be doing. The economy needs someone to decide to borrow some money and start a new firm that employs these newly unemployed people. But with the volume of consumption going down so rapidly, nobody’s really in the mood to start a new business. And existing businesses are busy scaling back production, not interested in borrowing money to ramp it up. The result of this is an overall fall in the average level of income. And that means that even with the share of income being saved going up, the actual level of savings can be going down and we can truly end up in the toilet.

The ultimate point of a fiscal stimulus policy is to avoid that toilet scenario. To get money flowing in the economy again, so that savings gets translated into investment which gets translated into jobs which pay salaries which, in turn, are spent and saved in ways that create jobs.

http://yglesias.thinkprogress.org/archives/2009/02/understanding_the_paradox_of_thrift.php