Careful with the paradox of thrift

Paul Krugman has just mentioned that the “paradox of thrift” has shown up in the data. Now my opinion has moved over time, and I do think that the US is now experiencing a paradox of thrift – but his evidence appears to have nothing to do with this.

I believe that we are hitting a “paradox of thrift” as unemployment in the US is at 9.5% and rising – that is a hell of a lot of wasted labour input, and implies to me that there is a large failure in the labour market reducing national output. As a result, if lower individual private savings could bring some of these guys back into producing it is possible that total private savings could rise (although it is not a given).

However, Krugman puts in the following graph and says this shows the paradox of thrift:

Now just a sec here, yes net national savings has fallen but the fact that net (aggregate) private savings has risen doesn’t say this is a paradox of thrift. For me, we only have conclusive evidence of a paradox of thrift if individual private savings and a proportion of income rose – but total private savings fell! We haven’t got that here so the numbers seem ambiguous.

An alternate explanation for the above graph is: we had a shock that lowered national income temporarily and as a result net national savings must fall. However, the government decided to just in and borrow heaps. Because of “Ricardian equivalence” households responded to government borrowing by saving. In this case we have government borrowing up, total borrowing up, and private borrowing down – just like now.

As I’ve said – I think the paradox of thrift could be happening, and I realise the above movement could be the result of it happening. However, this isn’t conclusive evidence of it – show me that people are saving more of income but that total household savings has fallen and we have an UNDENIABLE paradox of thrift.

14 replies
  1. Mattyoung
    Mattyoung says:

    Go back to the original BEA and examine what started first, decrease in government savings or increase in personal savings. A more likely explanation is that consumers freaked out when they saw state and federal government spending going haywire, especially in California.

    Not my theory, but is is a better theory drawn from the original chart.

  2. Greg Ransom
    Greg Ransom says:

    For the last 3 years I’ve been telling my wife to begin preparing for massive tax increases.

    We live in California. The first wave has already hit …

  3. jack gu
    jack gu says:

    Not only in the US, unemployment is rising in most other parts of the world especially in the export dependent sectors. Savings do help in such times. I completely agree with the Paradox of thrift.

  4. Jim Rome
    Jim Rome says:

    Remember, that these figures are calculated using U-3. The U-6 unemployment numbers for some of these states probably exceeds 20%, which is substantially higher than the numbers for the comparable period of 1930 (today is comparable to 1930 because we are one year or less into the current financial crisis). Indeed, unemployment is accelerating, and so by the end of this year, unemployment could be even higher.

  5. Matt Nolan
    Matt Nolan says:

    @Jim Rome

    U-6 unemployment is an exaggeration – as it also captures people in the labour force who do not want to work at the current wage. While it is important to figure out how much labour is underutilized (they do that in NZ) we have to be careful not to mis-specify it.

    “Indeed, unemployment is accelerating, and so by the end of this year, unemployment could be even higher.”

    Yes, unemployment will keep rising even when the economy has stopped contracting as firms move back towards full time staff and reinvest in capital.

    However, hours worked will be the series to look at. It looks terrible at the moment – but once that starts to pick up things will be looking better.

  6. steupz
    steupz says:

    Well I don’t think Krugman was conclusive in his description. He seemed to suggest the paradox was looming as consumers weighed down by high interest credit card debt, inevitably rein themselves in.

    The thing about that though, is, are people actually saving or paying off debt? And will these payments have any effect.
    I think the paradox might be that consumers may actually service their debt during this recession in greater numbers than we foresaw.

  7. Internet Marketing IQ
    Internet Marketing IQ says:

    I am a USA Citizen and surprisingly I went to College. Along the way I learned a little bit about the “Invisible Bankers” (Insurance Companies), and the Central Bank (Federal Reserve). The average American Citizen is absolutely clueless as how the Federal Reserve works and who is really in control. The Obama administration is full of Wall Street Appointees. It’s a do as I say not as I do administration. Sad, but it would be the same had his opponent one. And you can statistically model any financial problem to death, but you will not arrive at the root cause until you look deep into the deception. Unemployment numbers do not reflect the people who are no longer drawing benefits, were fired (A whole lot of companies will deny benefits even to those laid off), and the under employed.

    USA citizens are slaves to debt and once the jobs collapse the defaults begin and the fear escalates. Who is going to pay the $35 billion in dismissed GM debt that is owed to all the small business who feeds their corporate machine? It just goes on and on. But the bottom line is until the Central Bank is eliminated and the credit markets are allowed to open up the devastation and slide will continue.

Trackbacks & Pingbacks

  1. […] rising sharply, which is a wasted resource, and will thereby reduce national income – paradox of thrift style.  The second concern is based on the medium term, they believe that the consumption share of GDP […]

  2. […] Now, because prices aren’t properly aligned we (are assuming that we) have a situation where a lack of demand is leading to a situation where markets don’t clear – if we could increase spending we could increase income and this would lead to a superior outcome. This is our paradox of thrift. […]

  3. […] Careful with the paradox of thrift at The Visible Hand in Economics […]

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