Keynes’s Paradox of Thrift Revisited
It is instructive to compare the Austrians’ treatment of increased saving and
consequent market adjustments with Keynes’s treatment of these issues. There
are two important differences. First, pre-empting any extended analysis of
changes in saving preferences was Keynes’s judgement that such changes are
unlikely to occur. Second, any increase in thriftiness, should such a preference
change actually occur, would in his reckoning have perverse consequences
for the economy.
Saving, in Keynes’s theory, is a residual. It’s what’s left over after people
do their consumption spending, which itself is dependent only (or predominantly)
upon incomes. In the Keynesian framework, the rate of interest has no
effect (or only a negligible effect) on saving behaviour. Hence an extended
analysis of a change in saving preferences was largely uncalled for. Keynes’s
analysis of the interest rate is carried out in terms of the supply and demand
for money (that is, cash balances) and not in terms of the supply and demand
for loanable funds. And to the extent that Keynes did deal with loanable
funds – or, more pointedly, investment funds – his focus was on the other side
of the loanable funds market. The demand for investment funds, in his view,
is subject to dramatic shifts owing to the uncertainties inherent in investment
decisions. A comparison of Keynesian and Austrian theories of the business
cycles, the Keynesian theory featuring a collapse in investment demand, will
be the subject of section 9.11.
Keynes’s judgement that saving behaviour is not subject to change was
accompanied by some degree of relief that this was the case. He argued that
an increase in saving would send the economy into recession. This is Keynes’s
celebrated ‘paradox of thrift’. If people try to save more out of a given
income, they will find themselves saving no more than before but saving that
unchanged amount out of a reduced income. That is, in their effort to increase
their saving rate, S/Y, by increasing the numerator of that ratio, they set a
market process in motion that increases the saving rate by reducing the ratio’s
denominator. What is the essence of this market process that produces results
so different from those envisioned by the Austrians? In summary terms, the
Austrian story about derived demand and time discount becomes, in Keynesian
translation, a story about derived demand alone.
The market adjustments envisioned by Keynes can be revealingly depicted
as an alternative sequence to the one shown in Figure 9.8. In Figure 9.9 the
same initial conditions of full employment are assumed. But in the spirit of
Keynes, the loanable funds market is drawn with relatively inelastic saving
and investment schedules. The initial saving schedule is labelled S(Y0) to
indicate that people are saving out of an initial level of income of Y0. As in the
Austrian story, we show an increase in thriftiness by a rightward shift of the
supply of loanable funds – from S(Y0) to S′(Y0). And, as before, there is
downward pressure on the interest rate. But in the Keynesian story, the
market process that might otherwise restore an equilibrium relationship between
saving and investment is cut short by a dominating income effect.
More saving means less consumption spending. And less consumption spending
means lower incomes for those who sell these consumer goods. It also
means reduced demand for the inputs with which to produce the consumables,
that is, a reduced demand in factor markets, generally.
The economy spirals downward as spending and incomes fall in multiple
rounds. With reduced incomes, saving is also reduced. As the process plays
itself out, the saving schedule shifts leftward from S′(Y0) to S′(Y1), where Y1 <
Y0. The negative income effect fully offsets the positive increased-thrift effect.
Both saving and investment are the same as before the preference change. But
with reduced consumer spending and no change – and certainly no increase
in investment spending, the economy has fallen inside the production possibilities
frontier. (In Figure 9.9 the upward-sloping line that intersects the frontier
suggests that the level of consumption in the thrift-depressed economy is lower
than it would have been had intertemporal coordination somehow been achieved
without the lapse from full employment. The parameters of this upward-sloping
‘demand constraint’ will be identified in section 9.11.)
The Hayekian triangle changes in size but not in shape. Note that even if
Keynes were to allow for the allocation of resources within the capital structure
to be achieved by changes in the interest rate, no thrift-induced reallocation
would take place – since (abstracting from possible changes in liquidity
preferences, which would only compound the perversities) the interest rate
does not change.
To isolate the consequences of increased thriftiness, it is assumed that
investment spending does not change at all. But, of course, if the recessionary
conditions dampen profit expectations in the business community, investment
spending will actually fall, exacerbating the problems caused by the increased
thriftiness.
The paradoxical – and perverse – consequences of an increase in thriftiness
are seen by Keynes as the unavoidable outcome of the market process.
In his own words, ‘Every such attempt to save more by reducing consumption
will so affect incomes that the attempt necessarily defeats itself’ (Keynes,
1936, p. 84). The economy simply cannot move along its production possibilities
frontier, and savers who push in that direction will cause the economy
to sink into recession. Keynes’s paradox of thrift stands as a summary denial
that a market economy has the capability of achieving and maintaining an
intertemporal equilibrium in the face of changing saving preferences. Relative
change in resource allocations within the capital structure are no part of
the story. Again, the wholesale neglect of all such structural changes is what
Hayek (1931) had in mind when he remarked that ‘Mr. Keynes’s aggregates
conceal the most fundamental mechanisms of change’.
It is instructive to compare the Austrians’ treatment of increased saving and
consequent market adjustments with Keynes’s treatment of these issues. There
are two important differences. First, pre-empting any extended analysis of
changes in saving preferences was Keynes’s judgement that such changes are
unlikely to occur. Second, any increase in thriftiness, should such a preference
change actually occur, would in his reckoning have perverse consequences
for the economy.
Saving, in Keynes’s theory, is a residual. It’s what’s left over after people
do their consumption spending, which itself is dependent only (or predominantly)
upon incomes. In the Keynesian framework, the rate of interest has no
effect (or only a negligible effect) on saving behaviour. Hence an extended
analysis of a change in saving preferences was largely uncalled for. Keynes’s
analysis of the interest rate is carried out in terms of the supply and demand
for money (that is, cash balances) and not in terms of the supply and demand
for loanable funds. And to the extent that Keynes did deal with loanable
funds – or, more pointedly, investment funds – his focus was on the other side
of the loanable funds market. The demand for investment funds, in his view,
is subject to dramatic shifts owing to the uncertainties inherent in investment
decisions. A comparison of Keynesian and Austrian theories of the business
cycles, the Keynesian theory featuring a collapse in investment demand, will
be the subject of section 9.11.
Keynes’s judgement that saving behaviour is not subject to change was
accompanied by some degree of relief that this was the case. He argued that
an increase in saving would send the economy into recession. This is Keynes’s
celebrated ‘paradox of thrift’. If people try to save more out of a given
income, they will find themselves saving no more than before but saving that
unchanged amount out of a reduced income. That is, in their effort to increase
their saving rate, S/Y, by increasing the numerator of that ratio, they set a
market process in motion that increases the saving rate by reducing the ratio’s
denominator. What is the essence of this market process that produces results
so different from those envisioned by the Austrians? In summary terms, the
Austrian story about derived demand and time discount becomes, in Keynesian
translation, a story about derived demand alone.
The market adjustments envisioned by Keynes can be revealingly depicted
as an alternative sequence to the one shown in Figure 9.8. In Figure 9.9 the
same initial conditions of full employment are assumed. But in the spirit of
Keynes, the loanable funds market is drawn with relatively inelastic saving
and investment schedules. The initial saving schedule is labelled S(Y0) to
indicate that people are saving out of an initial level of income of Y0. As in the
Austrian story, we show an increase in thriftiness by a rightward shift of the
supply of loanable funds – from S(Y0) to S′(Y0). And, as before, there is
downward pressure on the interest rate. But in the Keynesian story, the
market process that might otherwise restore an equilibrium relationship between
saving and investment is cut short by a dominating income effect.
More saving means less consumption spending. And less consumption spending
means lower incomes for those who sell these consumer goods. It also
means reduced demand for the inputs with which to produce the consumables,
that is, a reduced demand in factor markets, generally.
The economy spirals downward as spending and incomes fall in multiple
rounds. With reduced incomes, saving is also reduced. As the process plays
itself out, the saving schedule shifts leftward from S′(Y0) to S′(Y1), where Y1 <
Y0. The negative income effect fully offsets the positive increased-thrift effect.
Both saving and investment are the same as before the preference change. But
with reduced consumer spending and no change – and certainly no increase
in investment spending, the economy has fallen inside the production possibilities
frontier. (In Figure 9.9 the upward-sloping line that intersects the frontier
suggests that the level of consumption in the thrift-depressed economy is lower
than it would have been had intertemporal coordination somehow been achieved
without the lapse from full employment. The parameters of this upward-sloping
‘demand constraint’ will be identified in section 9.11.)
The Hayekian triangle changes in size but not in shape. Note that even if
Keynes were to allow for the allocation of resources within the capital structure
to be achieved by changes in the interest rate, no thrift-induced reallocation
would take place – since (abstracting from possible changes in liquidity
preferences, which would only compound the perversities) the interest rate
does not change.
To isolate the consequences of increased thriftiness, it is assumed that
investment spending does not change at all. But, of course, if the recessionary
conditions dampen profit expectations in the business community, investment
spending will actually fall, exacerbating the problems caused by the increased
thriftiness.
The paradoxical – and perverse – consequences of an increase in thriftiness
are seen by Keynes as the unavoidable outcome of the market process.
In his own words, ‘Every such attempt to save more by reducing consumption
will so affect incomes that the attempt necessarily defeats itself’ (Keynes,
1936, p. 84). The economy simply cannot move along its production possibilities
frontier, and savers who push in that direction will cause the economy
to sink into recession. Keynes’s paradox of thrift stands as a summary denial
that a market economy has the capability of achieving and maintaining an
intertemporal equilibrium in the face of changing saving preferences. Relative
change in resource allocations within the capital structure are no part of
the story. Again, the wholesale neglect of all such structural changes is what
Hayek (1931) had in mind when he remarked that ‘Mr. Keynes’s aggregates
conceal the most fundamental mechanisms of change’.
No comments:
Post a Comment