Analysis of the Paradox of Thrift during Two Great Recessions
The argument begins from the observation that in the condition of equilibrium, total income must be equal to total output. Income has a direct effect on saving. Other things being equal, an increase in the autonomous component of saving, will move the equilibrium point at which income equals output to a lower value, thereby inducing a decline in saving that may more than offset the original increase.
Keynes rejected the classical economy theories that 1. Output and prices will eventually return to a state of equilibrium. He was not as optimistic about the natural equilibrium of the market. He believed the government was in a better position than market forces when it came to creating a robust economy. 2. Cutting of wages can restore full employment, by arguing that employers will not add employees to produce goods that cannot be sold because demand is weak.
In this form it represents a prisoner's dilemma as saving is beneficial to each individual but deleterious to the general population. This is a "paradox" because it runs contrary to intuition. However, exercising thrift may be good for an individual by enabling that individual to save for a "rainy day", and yet not be good for the economy as a whole. Keynesians Said that consumption, or spending, drives economic growth. Thus, even though it makes sense for individuals and households to cut back consumption during tough times, this is the wrong prescription for the larger economy. A pullback in aggregate consumer spending might force businesses to produce even less, deepening the recession. This disconnect between individual and group rationality is the basis of the savings paradox.
Keywords - Paradox, Thrift, Depression, Investment, Employment