Thoughts on Thrift

I know it’s been a while since I blogged last.  I blame the Turks.

 

Anyway, I’d like to discuss the Paradox of Thrift.  John Keynes says that, in bad economic times, people will keep money in their pockets, thus perpetuating the recession.

Keynesians would say spend for investments.  Others would say to save money to supply loanable funds for investments.

On both sides, you are talking extremes. One says only consumption is wrong. The other says only saving is wrong. But both sides are correct in this matter.

What we want is some spending and some saving. It’s ok to buy some things on credit (a house, for example), but you do not want to be going nuts. Unnaturally low interest rates will cause this to happen.

Likewise, it’s ok to save money for future (retirement, for example). But you don’t want to put every penny you earn int your account. Unnaturally high interest rates will do this

There is a way to reach the desired equilibrium of spending and savings. Just as prices coordinate supply and demand, interest rates coordinate savings and consumption (loanable funds and investment). If we allow interest rates to naturally develop in the same manner prices naturally develop, we can reach a level of savings and spending where the economy can grow. If we continue to try and manipulate interest rates, we will continue to see bubble after bubble, like the Tech Bubble (savings bubble), the Housing Bubble (spending bubble) or the soon-to-be Higher Education bubble (spending again).

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