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The Paradox Of Thrift ......

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As many have observed recently, the paradox of thrift presents us with a problem during a recession. I understand the paradox of thrift to mean that attempts to increase savings during a recession are self defeating because the negative impact on aggregate demand means that total increases in savings will actually be smaller than individual savers assumed.

The way that many seem to think about savings results in an outcome where we include debt repayment as savings. If we consider balance sheet repair by addressing liabilties as savings, then I think that there is only an illusion of thrift.

The risks of financial debt are significantly larger (in my opinion) than the benefits of financial assets. Balance sheet repair might be a necessary condition for aggregate demand to recover. When times are tough and people are in a precarious position, they are only likely to start spending more when they have regained control over their financial position.

While I can see that paying down debt has the same impact on aggregate demand as building up savings, do people think that the net impact of paying down debt in a recession to repair balance sheets (the illusion of thrift) is the same as building up actual savings (the paradox of thrift)?

I don't know enough about Keynes' work to know whether his popularisation of the problem of increased savings during a recession considered the initial net financial position of economic agents.

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It comes down too this.

Spend your money so that others will be better off, good for others and eventually you, but bad for you if no one else spends.

Save your money so that you are better off, bad for others and eventually you. but good for you if every one else has spent.

That is the problem.

I will act in my own self interest.

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Gordon Brown increased taxes during the good times, as suggested by Keynesian Economics, he then spent these increased taxed + 25% borrowed extra, which is the exact opposite of what Keynesian Economics specifies.

He should have been slowing the economy down in the good times by increasing taxes and saving it, instead, he did the exact opposite.

Keynesian economic policy isn't really an option any more.

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It comes down too this.

Spend your money so that others will be better off, good for others and eventually you, but bad for you if no one else spends.

Save your money so that you are better off, bad for others and eventually you. but good for you if every one else has spent.

That is the problem.

I will act in my own self interest.

Does it matter whether "money", as you have used the term, is from borrowings or savings?

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The way that many seem to think about savings results in an outcome where we include debt repayment as savings. If we consider balance sheet repair by addressing liabilties as savings, then I think that there is only an illusion of thrift.

except that that is totally invalid because savings used to pay down debt (de-leverage) are removed from the money supply - this is what makes it impossible for everyone to de-leverage at the same time. It is quite possible for everyone to save at the same time as long as the investment demand for those savings is there.

Savings which are used for investment (e.g. savings in normal non recessionary times) don't result in a reduction in the money supply because they are consumed and spent back into the economy by whatever entity is being invested in.

the paradox of thrift is I'm afraid quite real. It is not an illusion.

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As many have observed recently, the paradox of thrift presents us with a problem during a recession. I understand the paradox of thrift to mean that attempts to increase savings during a recession are self defeating because the negative impact on aggregate demand means that total increases in savings will actually be smaller than individual savers assumed.

The way that many seem to think about savings results in an outcome where we include debt repayment as savings. If we consider balance sheet repair by addressing liabilties as savings, then I think that there is only an illusion of thrift.

The risks of financial debt are significantly larger (in my opinion) than the benefits of financial assets. Balance sheet repair might be a necessary condition for aggregate demand to recover. When times are tough and people are in a precarious position, they are only likely to start spending more when they have regained control over their financial position.

While I can see that paying down debt has the same impact on aggregate demand as building up savings, do people think that the net impact of paying down debt in a recession to repair balance sheets (the illusion of thrift) is the same as building up actual savings (the paradox of thrift)?

I don't know enough about Keynes' work to know whether his popularisation of the problem of increased savings during a recession considered the initial net financial position of economic agents.

The Austria school of economic will say that there is a demand if the price is right and there is no paradox of thrift - just the wrong price.

For example, people will buy the house/build that extension if the price is deemed to be cheap and will not do it if it is deemed to be expensive (although some do it of course if they think the money they have just spend will go round and bid the house price up ever more....).

There is some truth to the paradox of thrift theory, but not the whole truth,

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except that that is totally invalid because savings used to pay down debt (de-leverage) are removed from the money supply - this is what makes it impossible for everyone to de-leverage at the same time. It is quite possible for everyone to save at the same time as long as the investment demand for those savings is there.

Savings which are used for investment (e.g. savings in normal non recessionary times) don't result in a reduction in the money supply because they are consumed and spent back into the economy by whatever entity is being invested in.

the paradox of thrift is I'm afraid quite real. It is not an illusion.

I used the word illusion to mean that deleveraging is not really savings. It is merely paying back money borrowed to pay for previous spending that has not generated sufficient income (if any at all depending on whether the previous spending was consumption or investment) to repay debt.

I agree that we can't all deleverage at the same time. I suspect that government and monetary authorities recognised this when they tried to replace private sector deleveraging with QE and increased public sector debt.

Now that this strategy seems to be falling into disrepute with many, I think that they are admitting that the inevitable outcome is for us to suffer a decline in living standards to one that is sustainable based on output rather than borrowing.

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The Austria school of economic will say that there is a demand if the price is right and there is no paradox of thrift - just the wrong price.

For example, people will buy the house/build that extension if the price is deemed to be cheap and will not do it if it is deemed to be expensive (although some do it of course if they think the money they have just spend will go round and bid the house price up ever more....).

There is some truth to the paradox of thrift theory, but not the whole truth,

except that is not what happens. If that was true companies would simply lower their wages and lower the prices they charge their customers, ad infinitum. It assumes infinitely flexible labour and money markets. But the labour market is not infinitely flexible and the money markets have a massive inflexibility in that rates cannot go below 0.

this means that while prices and wages can in theory adjust, unless debt also adjusts there can be no austrian equilibrium attained.

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except that is not what happens. If that was true companies would simply lower their wages and lower the prices they charge their customers, ad infinitum. It assumes infinitely flexible labour and money markets. But the labour market is not infinitely flexible and the money markets have a massive inflexibility in that rates cannot go below 0.

this means that while prices and wages can in theory adjust, unless debt also adjusts there can be no austrian equilibrium attained.

Another Keynes versus Hayek argument it seems.

Default or inflation are the choices.

Savers are in for a torrid time either way.

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As many have observed recently, the paradox of thrift presents us with a problem during a recession. I understand the paradox of thrift to mean that attempts to increase savings during a recession are self defeating because the negative impact on aggregate demand means that total increases in savings will actually be smaller than individual savers assumed.

The way that many seem to think about savings results in an outcome where we include debt repayment as savings. If we consider balance sheet repair by addressing liabilties as savings, then I think that there is only an illusion of thrift.

The risks of financial debt are significantly larger (in my opinion) than the benefits of financial assets. Balance sheet repair might be a necessary condition for aggregate demand to recover. When times are tough and people are in a precarious position, they are only likely to start spending more when they have regained control over their financial position.

While I can see that paying down debt has the same impact on aggregate demand as building up savings, do people think that the net impact of paying down debt in a recession to repair balance sheets (the illusion of thrift) is the same as building up actual savings (the paradox of thrift)?

I don't know enough about Keynes' work to know whether his popularisation of the problem of increased savings during a recession considered the initial net financial position of economic agents.

Not likely from reading his General theory of Employment...etc.

As far as I could tell it was drivel. Really poorly structured. Full of partial analyses. I was astounded to read it.

The other thing I've always wondered about was how the deflation resulting from general thrift actually increases the value of the savings.

I really don't buy the paradox of thrift. It has not been convincingly argued. If you imagine a model village economy trying to save, they will produce things of value like crops for storage. There will be a shift of resources from consumption to investment in productive enterprises.

I think the difference between a society deleveraging and one trying to save should be the difference between losing productive activity to debt payments (i.e. working for your creditors) and increasing production and investment in production (working for yourself).

I don't see why saving per se should result in a debt deflation trap. Even if people are paying down debt, if that debt is held internally in the economy then these payments should stimulate demand from the creditors.

Only in a situation of mass default does a debt deflation trap (thrift paradox) seem likely, because currency might be hoarded rather than invested to guard against default risk. And of course the best medicine longterm for default risk to get everything defaulted as promptly as possible! The situation of high default risk surely is a problem with malinvestment. And surely malinvestment can only be made worse by a reflation of the bubble that caused it.

The idea that you can borrow to "stimulate aggregate demand" and that this will eventually somehow magically create productive investment that dwarfs the original malinvestment (and thus makes everything ok) seems absurd. The reason asset prices start to crash is because they are valued far above their worth in terms of cashflow (i.e. ultimately what (produced) things of value people are willing to pay for them). If this is true in aggregate through an economy then there are simply not enough things of value being produced for the cashflows imputed by the asset prices. How can reflation work? It will simply further increase asset prices without increasing value production!

This problem is that price signals are distorted towards assets at the cost of underlying value streams. So resources end up being diverted from value production and towards the sector with the price distortion. Reflation is and attempt to stabilise this price distortion, so it actively prevents the rebalancing to value production whilst all the while hoping that value production will catch up with the distorted asset class!

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Now that this strategy seems to be falling into disrepute with many, I think that they are admitting that the inevitable outcome is for us to suffer a decline in living standards to one that is sustainable based on output rather than borrowing.

what output? output is only sustainable at any level if saving=investment (or equivalently saving=borrowing)

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Another Keynes versus Hayek argument it seems.

Default or inflation are the choices.

Savers are in for a torrid time either way.

inflation is not an option. inflation is only possible if people can be convinced to keep borrowing. That was the strategy after the 80s 90s recessions. Worked then (because median age was still well below 50-55), won't work now because the population has passed peak spending.

its going to be default. it will be a torrid time for everyone that will end in the collapse of capitalism unless people can get their heads round a negative nominal rate, which is nothing more nor less than a market mediated default.

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<snip>

The other thing I've always wondered about was how the deflation resulting from general thrift actually increases the value of the savings.

<snip>

An excellent point that I hadn't considered before.

Once it has set in, deflation is quite continuous. Defaults are discontinuous.

At a 5% annual rate of deflation, savers could sustain a 40% write-off of their assets every 10 years as long as they didn't get complacent about asset values in the non write-off years.

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what output? output is only sustainable at any level if saving=investment (or equivalently saving=borrowing)

I think that you are thinking in terms of money. I am thinking in terms of things.

I would exclude the value of rents, financial intermediation etc from my definition of output.

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except that that is totally invalid because savings used to pay down debt (de-leverage) are removed from the money supply - this is what makes it impossible for everyone to de-leverage at the same time.

Obviously untrue. If Bob pays me back my tenner with interest, the money supply is just fine, now back in my wallet.

I think you are thinking of external debt. Why make a partial analysis by considering only part of a system?

It is quite possible for everyone to save at the same time as long as the investment demand for those savings is there.

The wish to save creates investment demand. Obviously. A village attempting to build up crop stores will generate plenty of investment demand (switched over from consumption presumably.) Me trying to save will create plenty of investment demand. Etc etc.

Savings which are used for investment (e.g. savings in normal non recessionary times) don't result in a reduction in the money supply because they are consumed and spent back into the economy by whatever entity is being invested in.

Those are the only real savings. What other savings are there? Cash under the mattress? That increases the value of circulating cash seeking investments.

the paradox of thrift is I'm afraid quite real. It is not an illusion.
It is real but only if there is mass default, i.e. shift away from malinvestment. But it is hardly a paradox. Everyone repudiates getting into debt for overvalued stuff...so there is less demand for overvalued stuff....so the price drops. It's just that since a large sector of the economy has turned out to be dross then the corollary is that almost everything, including labour, is vastly overvalued. A simplistic Austrian response to this "the price needs to drop" is inadequate for this reason:

The price of much labour may be below that required to feed them. For example, Kirsty Allsopp. That is just one of the reasons why free market economics can't fix all perceived large social problems (ok, bad example, that actually fixes one social problem).

Labour not only has to get cheaper, but in order to be worth paying a "living wage" it must be able to do something valuable.

The huge adjustments needed following a malinvestment bubble collapse not only take time to accomplish, but may be further delayed by poor market visibility re what is actually going to be valued by society over the investment period?

If everyone merely decides to try to increase net worth (i.e. save) in relatively stable conditions without huge price distortions, then the economy would take off like a rocket because it would be engaged flat out in producing stuff of durable value.

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inflation is not an option. inflation is only possible if people can be convinced to keep borrowing. That was the strategy after the 80s 90s recessions. Worked then (because median age was still well below 50-55), won't work now because the population has passed peak spending.

its going to be default. it will be a torrid time for everyone that will end in the collapse of capitalism unless people can get their heads round a negative nominal rate, which is nothing more nor less than a market mediated default.

We are at negative real rates over much of the term structure currently.

A positive real rate and a negative nominal rate is the best after tax outcome for savers unless an asset tax is also brought into play.

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what output? output is only sustainable at any level if saving=investment (or equivalently saving=borrowing)

Absolute partiall analysis ******** again. In order to avoid classical economic partial analyses you can consider closed model systems. Barter systems are best of all because it avoids the classic trap you always fall into which is to equate currency with value and then implicitly regard it as a fixed ratio for the remainder of your analysis.

Everyone in the village this year suddenly produces plenty of high quality storable food, lovely durable clothes, fine art, great tools. What do you think happens? Is this wave of output "unsustainable" unless there is some abstract quantity called "investment" to match? Or do people in the village simply exchange these lovely things with each other and realise that they are vastly richer in aggregate? Can you now plug in a currency system into this village without your head exploding?

How would you define "savings" and "investments" under these conditions? Is there a strict mathematical relationship and what is it? Have you accounted for changes in the value of the currency?

Numpty.

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We are at negative real rates over much of the term structure currently.

only because of the deficit. Remove just some of of that Keynesian boost and there won't be any inflation.

A positive real rate and a negative nominal rate is the best after tax outcome for savers unless an asset tax is also brought into play.

I agree. I'd like to see initially, a negative nominal rate that equates to a 0% real rate, with baby steps taken towards that goal (since the nominal rate would need to be somewhere near -2.9% in the US right now to achieve that I think and that is far too much for people to get used to all in one go).

We should see how that goes for a while and whether it results in overall reduction of debt-gdp ratio (presumably both GDP and overall indebtedness would be declining under a -ve nominal rate situation) over time. If it does not one has to realise that only a negative real rate will remove the debt overhang. Think 2% inflation targeting in deflationary conditions, which would set a -ve nominal rate that would set the real rate around -2%.

Assuming that gets rid of the debt overhang in time, I would say ditch the 0% bound permanently which would allow us to ditch inflation targeting (no 0% bound means no need to target 2 rather than 0), and get rid of much of the deposit insurance infrastructure, and get rid of the need for any deficit spending whatsoever (though there is no reason the government budget can't oscillate around balanced conditions withni some reasonable range).

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I think that you are thinking in terms of money. I am thinking in terms of things.

I would exclude the value of rents, financial intermediation etc from my definition of output.

Isn't that just the problem?

Scepticus never defines his base terms such as "savings" and "factors of production".

From one of his beloved accounting identities we may infer he thinks savings are defined narrowly as money lent to someone else.

From his remark that debt repayment saving takes money "out" of the economy we might infer that...well, God knows.

If savings are money lend to someone else then they bear little relationship to the accumulation of value, which is what people on earth mean by saving. So to scepticus buying the most toxic MBS is saving whereas acquisition and improvement of farmland, buying bullion, or stuffing cash under the mattress is not.

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Everyone in the village this year suddenly produces plenty of high quality storable food, lovely durable clothes, fine art, great tools. What do you think happens? Is this wave of output "unsustainable" unless there is some abstract quantity called "investment" to match? Or do people in the village simply exchange these lovely things with each other and realise that they are vastly richer in aggregate? Can you now plug in a currency system into this village without your head exploding?

a barter model works fine. Because if you don't barter your own output you either consume it yourself or you leave it to rot.

the problem comes when you add a fiat money token (including gold) which is supposed to somehow store future purchasing power without guaranteeing that the output will actually be there in future.

as soon as people start to prefer to hold money than actual output goods, then the problems begin.

Numpty.

:rolleyes:

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If savings are money lend to someone else then they bear little relationship to the accumulation of value, which is what people on earth mean by saving. So to scepticus buying the most toxic MBS is saving whereas acquisition and improvement of farmland, buying bullion, or stuffing cash under the mattress is not.

farmland improvement is investment. saving implies the saving of financial assets.

this is because the the vast majority of physical output of the economy cannot be stored practically for any length of time. so by definition the only item of value that can be carried indefinitely into the future is intangible things like a promise.

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a barter model works fine. Because if you don't barter your own output you either consume it yourself or you leave it to rot.

Or store it as reserves. Or use it to produce more things of value.

the problem comes when you add a fiat money token (including gold) which is supposed to somehow store future purchasing power without guaranteeing that the output will actually be there in future.

as soon as people start to prefer to hold money than actual output goods, then the problems begin.

No, don't see a problem with, say gold or cowrie shells (no debt so far) beyond the. Just run through the paradox of thrift for me in such a system (please)?

And can you also define "savings" as you use the term please? And explain how savings must equal "investment" in such a system for the production to be sustainable. This was your point that I was responding to.

Edited by mirage

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farmland improvement is investment. saving implies the saving of financial assets.

Define financial asset. It is a bit of paper collateralised by farmland? Is buying such a bit of paper an investment or a saving?

this is because the the vast majority of physical output of the economy cannot be stored practically for any length of time.

All of the physical value of an economy (and planet) is stored practically for great lengths of time. It's called Earth and its ecosystems.

so by definition the only item of value that can be carried indefinitely into the future is intangible things like a promise.

Erm. Nope. A promise is stored (or not) in just the same way all those other intangible things like skills, poetry, knowledge and goodwill. [Edit - or legal title (ownership)]. In other words a hell of a lot less durable than things like gold, farmland or the sea. A financial asset is:

1. not clearly defined by you.

2. Just a subset of any number of things of value that may or not survive and may or may not hold their value.

Edited by mirage

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  • 145 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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