If everyone saves more at once in a depressed economy, spending falls, incomes fall, and total saving may end no higher.
Keynes made it central to the General Theory in 1936, with Mandeville and others anticipating it. One household's saving is prudent; every household saving at the same moment removes the demand that paid their wages. The claim is conditional on an economy running below capacity and on the absence of an offsetting fall in interest rates or rise in investment, which is exactly where the argument between schools of economics lives.
In practice
- A recession begins, every firm cuts its budget at once, and the cuts remove the customers those budgets were meant to protect.
- A family stops spending to rebuild its savings and finds its income falls when its employer's customers do the same.
- Possible explanations
- The explanation is circular flow: one household's spending is another's income, so simultaneous saving removes the demand that paid the wages the saving came from.
- In its favour
- It holds where output is demand-constrained, and the pattern was visible in the recessions of the 1930s and after 2008, when private saving rose as incomes fell.
- Against it
- Economists who hold that saving is channelled into investment through interest rates reject it, and where an economy is at capacity the mechanism does not apply, so the claim is conditional rather than general.
- Standing
- Contested across schools: accepted in demand-side macroeconomics for an economy below capacity, rejected by economists who hold that saving is automatically channelled into investment. Compare the tragedy of the commons for the general shape.
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money