One of the things that I never understood about Keynsian economic theory is the issue of spending vs. saving. How's that for an obscure start to a blog post? These days you hear all about government economic stimuli and how the government needs to spend more money to offset declining spending in the private sector. Supposedly, us wretched members of the public are so concerned about our own economic fate that we are spending less and saving more (the savings rate hit 5% in January, up from virtually nil last summer). Government must pick up the slack and get the economy going again, or so the explanation goes. The theoretical economic basis for such government intervention was developed by influential 20th century economist John Maynard Keynes.
However, I never understood how and why the fact that members of the public started saving more could be a bad thing. After all, when you save money it goes into a bank, which uses your money to lend to other people who in turn use the cash to invest or spend. Savings equal investment. Yes? I understood the supposed logic behind government stimulus, but I never understood why consumer retrenchment in the form of savings could actually cause an economic downturn.
Well, this weekend I listened to an episode of EconTalk which covered this exact question. This excellent weekly podcast consists of an hour long discussion between two economists, covering a different topic every week. It's an intelligent discussion - not exactly dumbed down, but the conversation is jargon free and largely accessible to anyone with even a basic grasp of subject matter. Consider it econ 101 on your iPod. Anyway, the episode I listened to covered the issue of Keynesian economics with guest Steve Fazzari (you can find it here). The host, Russ Roberts, asked Fazzari the question that has been on my mind all this time but which I never bothered to explore: how can it be that a higher rate of savings causes an economic slowdown? A 30 minute discussion ensued which essentially boiled down to this:
Consider John who eats out every work day at a local restaurant. If John decides to save more and bring a bagged lunch from home, he will reduce his spending by say, $5 a day. His savings will go up by $25 a week. However, the restaurant owner will see his income reduced by $25, and therefore will either need to reduce his own spending by $25 a week or else his savings will be reduced by the same amount. The fact that our protagonist decided to boost his savings by $25 did not raise the total savings in the economic system. All it did was move the savings from the restaurant owner to John. This is like conservation of energy applied to money... maybe we can call it conservation of savings? Since no more savings exist in the system, no more investment exists in the system. All that changed is that the restaurant owner is now seeing a lower income. Interesting...
I don't know if I fully grasp or buy this explanation, but I am very intrigued. I have been thinking about this idea for a couple of days, and it seems to hold water so far. I think I want to learn more about the subject.
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