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The Paradox of Thrift
John Maynard Keynes explained the paradox of thrift as a change in the economic
balance a result of increase savings. The paradox asserts that, during recessions, individuals tend
to save more of their income. However, as the savings increase, the aggregate demand decreases.
This creates a situation where supply exceeds demand. The overall scenario is that savings
eventually decrease (Melvin and Boyes 217).
Keynes suggested that reduce savings during recessions reduces spending. As such, this
stalls other economic activities that depend on consumption. The economic situation deteriorates
due to the savings since one person spending is another person’s income. The intuition here is
that spending improves production, which in turn leads to employment of people, who then earn
wages. The earning and spending cycles continue until the economy is out of recession.
In the short run, savings reduce the funds that are available for spending. As stated above,
the scenario is counterproductive as it inhibits production, thus affecting other macroeconomic
variables such as employment. The collective chain reaction of savings and consumption causes
diminishing rate of savings where in the end, the savings rate become unsustainable.
The arguments are valid since savings reduce the marginal propensity to consume. This
implies that aggregate demand lowers. As the aggregate demand lowers many firms lower
production, which in turn reduces a firm’s income. The final impact is that firms will cut labor
due to a fall in their income. It is argued that savings are a withdrawal to the circulation of
income. Thus, savings that are not invested are not beneficial to the economy (Dwivedi 115).
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The cause effect relationship suggests that the savings are counterproductive in the short run.
In the long run, savings are believed to have very desirable impacts on investments.
Keynes argued that individuals can use the savings they have massed to undertake investments.
This increases the gross domestic product, hence economic growth. According to Keynes,
savings are a non-dispensable factor that determines investments. The long run effect assumes
that people do not hoard their savings and use them for economic purposes.
An increase in savings reduces the interest rates. The result is that there will be no desire
to save more. As the marginal propensity to save declines, people take on investment
opportunities. The investments tend to correct the short run effects by increasing the domestic
product and also increasing employment opportunities.
At equilibrium, the total income, which insinuates demand, must be equal to the total
output. This implies that savings cause an imbalance in income and output. Consequently, the
equilibrium condition outlines that total savings must equal investments. Thus, savings for
investment purposes is a good strategy for enhancing growth (Meltzer 70). Keynes argued that
the economy will always find its way to the equilibrium through auto adjustment of factors that
cause disequilibrium. An increase in savings in the long run will impact on investments that will
in turn increase output. Increase in output is an indicator of economic growth. Thus, savings are
beneficial and productive in the long run.
In conclusion, savings are an important element for economic growth. As observed in the
paradox of thrift, collective savings are detrimental to the economy in the short run. However, in
the long run, savings are used for investments that in turn trigger growth. I thus concur with
Keynes theory on the paradox of thrift.
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Works cited
Dwivedi, D N. Macroeconomics: Theory and Policy. New Delhi: Tata McGraw Hill Education Pte Ltd, 2010.
Print.
Melvin, Michael, and William J. Boyes. Principles of Macroeconomics. Mason: South-Western Cengage
Learning, 2013. Print.
Meltzer, Allan. Keynes's Monetary Theory: A Different Interpretation. Cambridge Univ Pr, 2005. Print.