Paradox of Thrift

Posted in Finance, Accounting and Economics Terms, Total Reads: 601
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Definition: Paradox of Thrift

It refers to the phenomena wherein during recession, people generally try not to invest and increase the savings and hence leading to a fall in economic growth. This idea was given by a famous economist, John Maynard Keynes. According to his idea, due to fall in consumer spending during recession and increase in savings, the economy is not able to grow further from the condition of recession. This is because, when one individual spends, it becomes income for another individual and this chain forms the value chain of any economy. Now, if the consumer starts saving rather than spending, the value chain distorts and many individuals in the economy lose their jobs, hence savings create more collective harm to economy rather than benefit.

When a consumer stops investing, naturally the demand for products and services goes low. And if the products and services are not sold for right price at right time then the employees of the companies producing such products and services lose their jobs leading to a flat or negative growth and hence it takes a lot of time to come out of recession and gain the consumer confidence, so that the consumer start investing.

Though the above theory looks pretty forward, there are many economists who oppose the theory given by John Maynard Keynes. One of the main arguments against the theory stated above, simply makes us to believe that the theory is not correct. The argument is that when the consumer stops investing and starts saving, the savings of the consumer will go to banks. Now, when banks have extra money to lend and invest, all the companies start investing and banks start lending making the interest rate fall down.

 

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