The Paradox of Thrift

The Bureau of Economic Analysis announced that the consumer saving as a percentage of disposable income went up to 5 Percent, the highest it has been in a while.

This might be good news in the long run, but in the short run for an economy that is sinking, this spells more trouble. Consumers saving more means, they are spending less money on other goods reducing their demand and inturn further driving down prices of goods and commodities. New automobiles sales decline of 40 percent for the top three car makers even with deep discounts can be attributed to lower consumer spending.

John Maynard Keynes called this the Paradox of thrift. According to him

Thrift may be a virtue for the individual, but could damage the economy as a whole. The more people saved, the more they reduced effective demand, thus further slowing the economy. Faced with slowing demand, businesses would not necessarily use the extra savings available in the economy to invest. As the slump in demand cascaded through the economy, the resulting slowdown would mean that everyone had less income - ultimately reducing the absolute amount of savings, even if people increase the proportion of their income they put aside. As unemployment grew, investment would fall, whatever the level of savings.

The current economic downturn seems to follow Keynes's script word for word.

Also read BBC Analysis on the Paradox of Thrift and my previous post To Save or Not to Save