An example of this was witnessed during the Great Recession that followed the financial crisis of During that time, the savings rate for the average American household increased from 2.
The Federal Reserve slashed interest rates in order to boost spending in the American economy. Mandeville argued for increased expenditure as the key to prosperity, rather than savings. Keynes helped revive the circular flow model of the economy. This theory states that an increase in current spending drives future spending. Current spending, after all, results in more income for current producers. Those producers rationally deploy their new income, sometimes expanding business and hiring new workers; these new workers earn new income, which then may be spent.
To boost current spending, Keynes argued for lower interest rates to lower current savings rates. If low interest rates do not create more borrowing and spending, Keynes said, the government could engage in deficit spending to fill the gap.
Capital machines, which drive higher levels of production, require additional savings and investment. The circular flow model only works in a framework without capital goods.
Also, the theory ignores the potential for inflation or deflation. If higher current spending causes future prices to rise concordantly, future production and employment will remain unchanged. Similarly, if current thrift during a recession forces future prices to fall, future production and employment need not decline as Keynes predicted. Finally, the paradox of thrift ignores the potential for saved income to be lent out by banks. When some individuals increase their savings, interest rates tend to fall, and banks make additional loans.
Economists remain divided about sticky prices. Ivan owns a factory that produces component parts for computers. The factory is among town XYZ's biggest employers. He has been planning to expand his production capacity by installing more machines and hiring new workers. However, a recession strikes and Ivan reverts to savings mode. He lays off workers and discontinues operating the machines at night time. Unemployed factory workers, who do not have income to spend, also begin saving, reducing demand for goods produced by Ivan's factory.
The unemployed factory workers also add to the town's overall spending on social benefits and its economy becomes weak.
A real world example of the savings paradox during the Great Recession was the case of to year-olds who moved in with their parents. The Paradox of Thrift " Accessed Oct. Actively scan device characteristics for identification.
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