Saving is good for the individual, but not for the economy as a whole.
People try to save more and therefore they spend less. Investment in the economy decreases.
This would not be a problem if credit was flowing smoothly, since saved money would be reinvested by the bank, however, credit has become harder to come by because of circumstances already described, this means there really is money being saved that is not being reinvested in the economy.
The economy as a whole is trying to sell more to save money and buy less, this creates a drop in demand. The drop in demand leads to a drop in revenues for comanies, downsizing, and unemployment. This means lower incomes, lower prices (deflation), and in turn less economic activity and even more saving. Possibly why banks are even more warry to lend right now.
You realize the fault in this don't you? It would mean that if one person gets fired, that demand would drop, so pay would go down by that amount. This would start a spiral whereby at the end no one works. But it doesn't work this way. Why?
Then what is the problem with the increased savings?
I suppose there is always foriegn investment. We don't live in a box. The government could take on defecits because of this. Companies will be invested in from abroad. Also people will take risks, and some may pay off.
I am sure that a growth in productivity during most recessions, or the invention of new technologies would also work against the creation of a never ending spiral.
Certain products will not have the demand drop as much as others as well. Certain commodities, mostly necessities, I am sure will not have a drop in demand regardless.
Increased savings is not the problem.......
Increased savings during times of decreasing incomes is a problem.
A lot has to do with our current situation. Not all recessions will result in a paradox of thrift. Not all are liquidity traps. It just happens to be that this one does fit those descriptions.
Because when credit is hard to come by we should stop saving and make credit even harder to come by?
So then a liquidity trap is responsible for the recession, and we should increase liquidity to get out of it? Explain then the early 1920s recession and why we got out of it even though we did the opposite of what we're doing now.
Some things actually see an increase in demand during recessions. You have to stop looking at aggregates because it blinds you to what is actually going on: shifting demand.
Another typical time frame error. Increased savings broadens long term credit availability. As dictated by reality... increased rates of savings during periods of decreasing income does not boost short run credit availability.
The 1919 recession was an after effect of WWI. A bad comparison if you ask me; a much more quality comparable one would arise only 9 years later (and central bankers adhered to the bold). What was the end result?
P.S.
The Keynesian remedy to a liquidity trap is to boost demand, as monetary policy is rendered ineffective FWIW....
The bold signifies some pretty harsh language. Ignoring economic indicators is never a good idea regardless of whether or not they adhere to your particular liking.
How does it not? If I'm an individual, the more I have, the more I can lend, short-term and long-term. What changes with a corporation?
So then a liquidity trap is responsible for the recession, and we should increase liquidity to get out of it? Explain then the early 1920s recession and why we got out of it even though we did the opposite of what we're doing now.
Goldenboy219 said:The bold signifies some pretty harsh language. Ignoring economic indicators is never a good idea regardless of whether or not they adhere to your particular liking.
I don't think that recession can be classified as a liquidity trap.
For the big picture I would agree with you. However, since obvouisly the entire economy has never been completely dismantled by a deflationary spiral, I am guessing something must break the chain. Possibly it is because not literally everything sees a drop in demand, despite a drop in AD. When looking at the macro level you need to be wary of the fallicy of composition, but also the fallacy of division.
Savings has been increased as income has simultaneously decreased. We can make all sorts of arbitrary comments about having more, but it is helpful to refer back to Friedman's permanent income hypothesis; people will desire to buy more/take out credit if their future income expectations is favorable.
You want lending to increase? It is absolutely essential that we boost demand!
Besides, what has the reality of the current situation told us? Savings has increased quite a bit, while lending... not so much.
So everything before the Great Depression was not a liquidity trap? That's convenient.
There are still companies making money out there though. When credit is hard to come by, they will get the loans while the companies that aren't will have a much harder time of it. This speeds up the loss function, which is essential for an economy. The faster the losses the faster the correction.
No, just not that recession. Interest rates were never close to zero during that time, they were actually high. The 1919 recession is similar to the one in the early 1980's in my opinion.
I am not so sure. It would seem to me it would just make faster losses. Not necesarily a faster correction.
For the big picture I would agree with you. However, since obvouisly the entire economy has never been completely dismantled by a deflationary spiral, I am guessing something must break the chain. Possibly it is because not literally everything sees a drop in demand, despite a drop in AD. When looking at the macro level you need to be wary of the fallicy of composition, but also the fallacy of division.
There are still companies making money out there though. When credit is hard to come by, they will get the loans while the companies that aren't will have a much harder time of it. This speeds up the loss function, which is essential for an economy. The faster the losses the faster the correction.
I've gone over this with you. 17x some arbitrary level means nothing. If the reserve ratio gets to 100% and there's still no lending then there may be a problem with what I'm saying.
My issue is in the bold. Volatility has to be considered, and faster losses leads to the unleashing of animal spirits. Psychology and heuristics then render market actions inefficient as panic (quite the contagious ****) begins to spread.
This is just a misunderstanding of basic finance. High levels of reserves is essentially a major symptom of a liquidity trap. BTW: 17x equates reserve ratio's at 170%:2wave:
If you're making money you can still get loans right? But if you're not, then loans will be harder to come by. These loans would otherwise keep these companies afloat but now they will just fail faster if they can't get credit. This will help shift production toward what people are really demanding.
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