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The Paradox of Thrift

Or, When Vice is Virtue, and Virtue Vice

Pinching coppers is a favorite European pastime

Personal savings rates in the United States have been on something of a wild ride this year. The relevant metric, aptly named the "Personal Saving Rate", is the amount of disposable personal income that is not spent on personal consumption. It's the coffees that you forgo when you're saving for that new car.

Prior to the COVID-19 pandemic's recognition, savings rates had spent the past five years oscillating between 6% and 8% per year. Once the spread and virulence of the virus became apparent and lockdowns ensued, rates skyrocketed to 33% in April of 2020. This was partly due to anxiety about the economy, as well as inability to spend, since much of the economy was also shut down to prevent additional community spread.

This rate has fallen over the months to 14.3% in September, partly as savings have been converted into consumption, and partly as unemployed Americans have spent down their savings. While the fall in savings rates from such stratospheric highs is a good thing, since one person's spending is another person's income, it is also a bad, since it indicates that many people are exhausting their emergency savings funds.

The savings rates figures, like many of the figures aggregated at the national level, obscure the truth of the matter. The $1,200 stimulus checks sent to eligible taxpayers as a result of the CARES act were primarily saved, rather than spent. In other words, they didn't have an appreciable impact for most employed workers. For workers whose earnings dried up as a result of lockdowns, these stimulus payments were eventually spent, resulting in a depletion of savings. So it is that savings rates remain high and continue to grow for high income earners; for low income workers, savings rates are falling drastically.

See the gray area for what savings look like in typical recessions
Personal Savings Rate, January 2008 - September 2020

This leads us to the 'Paradox of Thrift', the idea that high personal savings rates are congruent with lower gross domestic product. Translated from the Economic, less spending and more saving has a depressive effect on economic growth, while more spending and less saving has a stimulative effect. This seems paradoxical because it appeals to reason that if all households exercise financial discipline, then the financial health of an economy comprised of those households should be good. This is what we call the 'Fallacy of Composition', or the imputation of the characteristics of a part to the whole: a baseball player has two legs; therefore, a baseball team has two legs.

For example, the Euro area as a whole has a personal savings rate 150-200% that of the United States', and typically sees lower GDP growth than the United States (also, milder recessions.) The difference in growth is not solely attributable to this, although it is a contributing factor; other factors are differences in birth rates, immigration rates, labor and market regulatory policy, among others. We mention this merely to demonstrate that a high personal savings rate does not produce superior economic growth and may, in fact, hinder it.

When unemployed workers reach the end of their savings, that support for economic growth will expire, and what has been acting as a brake on the economy will bring it to a sudden halt. Ordinarily monetary policy could provide additional economic stimulus through lowering interest rates or loosening reserve requirements. As we are at the zero lower bound, monetary policymakers find themselves in a liquidity trap, wherein ordinary measures no longer have room to boost demand and therefore the economy. It's up to the political establishment to provide additional fiscal expansion. Unfortunately, without additional fiscal stimulus, the United States' nascent economic recovery will end, and we'll face a much longer and darker winter than necessary.

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