The Paradox of Thrift during our economic stagnation

ABOUT ninety years ago, British economist John Maynard Keynes explained how individual and family thrift can be harmful for a market economy.

This is a paradox because the Judao-Christian ethic (and most other major religions) teach us that saving more today (and spending less) helps us build a more prosperous future.

Keynes explained that when we (households and individuals) increase our savings more than businesses expect us to do, we spend less than what is needed to purchase the goods and services businesses create.

When this happens businesses cannot sell what they produced and they reduce production and lay-off workers until their unsold items are finally purchased.

This is one cause of unemployment in a market economy.

For this reason, economists try to understand the factors which influence consumer decisions which determine the allocation of their disposable income between consumption and saving.

Some are self-evident. Families with higher than average income usually save a higher percent of their available funds than those with lower incomes.

Families which experience a loss of income (through job loss, health crises, or any other event) suddenly spend less on discretionary items and more on essentials. Households with positive changes in their income do the opposite.

Changes in wealth also affect these decisions. An increase in wealth (stock market gains or increased value of real estate) itself represents an increase in saving and households experiencing this benefit often respond by increasing their spending.

Remember how many households acquired home equity loans to fund spending binges when their home values soared before the great recession 12 years ago? A drop in wealth can have the opposite effects.

One of Keynes’ most important contributions to our understanding of household behavior, however, was that our expectations of our future income plays a powerful role in our division of disposable income into savings and spending.

When we expect a loss of income, most of us reduce our spending in order to put some funds aside for the bad (or rainy) days to come. When we expect to have larger incomes in the future, most of us are more willing to allocate more money to spending and less to savings.

The need to understand how consumers view their economic future has led the Institute for Survey Research at the University of Michigan to develop a monthly measurement of consumer confidence (called the Consumer Sentiment Index).

This statistic is now one of eleven inputs the Federal Department of Commerce uses to create its composite index of leading economic indicators. Businesses use these data to develop their plans for future production and employment.

The problem is that household or consumer confidence can vary widely. Since fear of the COVID-19 pandemic developed, the Consumer Sentiment Index has fallen more than 30%. During this same time, the savings rate of American households has almost doubled.

During past periods of high economic growth, savings increases were needed to support business expansion. Today, however, the meaning of Keynes’ paradox is painfully clear.

Until households have a more positive view of the future, their high savings rates will make it difficult, if not impossible, for our economy to return to the high employment (or low unemployment) we have recently enjoyed.

The high savings rates mean that households will not purchase all the goods or services business have produced and many laid-off employees will not be called back for some time.

The impact on travel and tourism will persist long after the current social distance restrictions are history for two reasons. Some people are not going to return as fast as possible because of the uncertainty associated with the virus and conflicting claims emanating from different levels of government.

People will also continue saving more and spending less than businesses expected them to do as long as this uncertainty persists.

We can, however, see three positive factors for our local economy. We may experience the resurgence of “staycation” spending by Americans who see even greater uncertainty (and the risk of two-week quarantine) associated with travel abroad.

Second, the Federal government has inserted trillions of dollars into households and businesses, without which the drop in demand for goods and services would have been terribly more severe.

Finally, the latest report on consumer confidence showed a slight increase.

Sadly, the need to bolster consumer confidence causes some politicians to minimize the threat or overstate our ability to beat the virus.

Both serve to increase uncertainty and reduce confidence. The economy needs firm, honest, and sincere messaging from leaders and until we receive it the rebound will be slow.

CS

Kenneth Zapp, PhD, is Professor Emeritus at Metropolitan State University and Mentor with SCORE Savannah.

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