The Paradox of Thrift

The paradox of thrift (or paradox of saving) is a paradox of economics generally attributed to John Maynard Keynes, although it had been stated as early as 1714 in The Fable of the Bees and similar sentiments dating to antiquity.

Keynes argued that consumer spending contributes to the collective good, because one person’s spending is another person’s income.  Thus, when individuals save too much instead of spending, they can cause collective harm because businesses do not earn as much and have to lay off employees who are then unable to save.  The paradox is that total savings may fall even when individual savings attempt to rise.  In this way, individual savings rather than spending can worsen a recession, and therefore be collectively harmful to the economy.

Consider the following example:

thrift boxes

In the above example, one consumer increased his savings by $100, but this cause no net increase in total savings.  Increased savings reduced income for other economic participants, forcing them to cut their savings. In the end, no new savings was generated while $200 income was lost.

This paradox is related to the fallacy of composition, which falsely concludes what is true of the parts must be true of the whole.  It also represents a prisoner’s dilemma, because saving is beneficial to each individual but deleterious to the general population.

The paradox of thrift is a central component of Keynesian economics, and has formed part of mainstream economics since the late 1940s, though it is disputed on a number of grounds by non-Keynesian economists such as Friedrich Hayek.  One of the main arguments against the paradox of thrift is that when people increase savings in a bank, the bank has more money to lend, which will generally decrease interest rates and thus spur lending and spending.

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