The Paradox of Thrift: When Saving Hurts the Economy  

Traditionally, saving money is seen as a positive action. Keeping money in reserve for emergencies and potential issues in the future is surely a good thing both for you and for those around you. However, this seemingly responsible and innocent action can have extraordinarily negative consequences for a nation’s economy and growth if savings reach excessively high levels. This phenomenon is described as the ‘paradox of thrift’, a concept popularised by John Maynard Keynes himself, which effectively states that excessive saving across a population can often lead to economic decline.   

Is it a paradox, or just an economic effect?  

The first step in the paradox comes from the individual rather than the collective. As one person decides to save money, they are making a responsible decision for their future and planning for worst-case scenarios in their own finances. However, this individual saving will then often lead to others around them beginning to save in a similar fashion (mainly due to human susceptibility to peer pressure and the feeling of obligation to follow the behaviour of the society one is a part of); this behaviour can sometimes spread through entire economies relatively quickly. This then leads to an overall reduction in demand for non-essential goods and services across an economy, leading to the typical economic indicators of a recession being observed, such as lowering sales figures, a general income per capita reduction, and declining job security. This indicates the presence of a strange phenomenon which can occur in an economy – lots of individuals taking seemingly rational action can lead to a collective irrational outcome.   

Following this initial instability, primarily due to the reduction in spending, the paradoxical nature of this concept begins to appear. As income levels go down, individuals in an economy are less able to spend and save, further reducing demand. As a result, economic growth slows once again, and the cycle repeats. Because of this, when saving occurs on an extreme scale, overall income tends to fall, meaning people are ultimately less able to save in the future. This is the heart of the ‘paradox of thrift’: increased saving can actually reduce saving in the long term.   

Why is it relevant today?  

Although economic systems and structures today are very different from when the paradox was first suggested by Keynes, there have been several examples in recent years where this phenomenon has threatened economic stability across various major economies.   

Covid-19 Pandemic  

During the pandemic, data show that household savings increased rapidly, up to almost 19% of household income being saved in the eurozone (a 7% increase from typical levels, which stand at 12%), and a similar trend was seen in the UK. Although some do argue that most of these savings were forced savings, rather than willing, that effect the saving has on the economy is the same regardless. This increase in savings led to reduced spending and therefore demand, a trend fitting in with the prediction Keynes made in his paradox of thrift; following this, unemployment and diminished job security followed, and this cycle would have inevitably continued if lockdown had not ended, as wages and spending would have continued to simultaneously decline.   

Cost of living crises  

In a cost of living crisis, Keynes’ paradox of thrift often emerges in the background of such crises, threatening economic stability and recovery. One of the key features of a cost of living crisis is a reduction in real disposable income across a population; this then means that earners and drivers of economic growth are less inclined to spend and circulate money around the economy, instead opting to save their income due to the heightened uncertainty they are experiencing. This again indicates the beginning of the self-reinforcing loop, which is the paradox of thrift; as saving increases, demand decreases, wages decrease, and the loop begins again.  

Policy implications and preventative measures  

In order to combat the risks associated with the paradox, governments can take various measures to discourage saving and increase spending in society to boost economic growth and maintain stability.   

Possible measures include:  

• Increasing government spending in public sectors such as infrastructure and health in order to allow these institutions and sectors to continue to thrive and spend, irrespective of the reduction in public consumption.  
• Lowering interest rates to encourage borrowing and therefore spending.   
• Introduce subsidies and tax cuts into sectors most impacted by reduced demand, such as entertainment or tourism, to revitalise said sectors.  
• Clear communication of intent and policy reform to reduce ‘waiting to spend’ behaviour in an economy.  

With regard to preventative measures, governments can include the following regulations in policy changes to mitigate severe economic downturns due to the paradox of thrift:  

• Tax credits/subsidies that automatically activate during times of economic downturn and reduced spending.  
• High levels of public investment in both public and private services to boost spending in the market from various corporations and sectors.  
• Offering research and development grants to increase advancement and development  
• Introduce clear support programs and ‘safety nets’ to increase confidence and risk-taking appetite to boost investment and spending.  
• Clear and concise communication about future goals and changes to reduce public uncertainty in an economy.