It is hard to disagree with the fact that individual saving is a good thing. Yet some economists argue that collective saving can also be bad because of the paradox of thrift, a theory credited to John Maynard Keynes.
Long and short-term savings
It is important to distinguish between the short term and the long term. In the long term, collective thrift (a higher marginal propensity to save) is usually a good thing, which is consistent with most people's logic and intuition: Don't spend more than you make. Don't buy things you don't need. Save for a rainy day.
In the short term, however, sudden increases in the collective savings rate can be potentially harmful to economic growth. If we all cut our spending in an attempt to increase our individual savings, our collective savings will paradoxically fall because "one person's spending is another's income, the fountain from which savings and investments flow," explains Paul McCulley, an economist and portfolio manager at asset manager Pimco.
This argument is often used to promote consumer spending in periods of economic uncertainty. It has also led governments to spend heavily during recessions to prevent the recessions from worsening.
Too much of a good thing
During the last recession, President Bush famously urged the American people to get out and shop and to thwart the downturn. They did, and the recession was mild. It was, however, followed by an explosion of debt: millions of Americans spent trillions of dollars on things that they couldn't afford, including houses. A painful reckoning was inevitable. In this case the consumer took over the counter-cyclical role usually played by government by using indebtedness and spending to stimulate a weak economy.
A balance between spending and saving
It may be that we are now collectively rediscovering savings. US consumer debt levels are falling. Consumer spending is down. The savings rate is on the rise. That’s good, right?
Not necessarily.
The sudden sobering up of the consumer happens to be a problematic force that is driving the US and global economies downward. And so the approach remains paradoxical: a healthy economy needs a balance between saving and spending.
To spark solid global economic growth, households need to be willing to spend and save. Consumers with jobs and secure incomes should continue to spend on things they need and can afford but remain mindful of saving for the future.
We live in a world of business cycles and in times of uncertainty individuals and households need a financial buffer. When someone loses a job, savings can be used to cover expenses and living costs. Individuals with this essential buffer of higher savings are also good for the economy over the long run since collective savings are the mechanism for investment.
Savings provide the basis for future consumption by the individual. They are important for economic growth and create a collective pool of money that businesses can borrow from to invest in technologies that will improve our standard of living in the future.