Public debt and Keynes’ paradox of thrift

13 Feb, 2015 at 17:24 | Posted in Economics | 2 Comments

thegeneraltheoryFor although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself. It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment.

When applied to the question of public debt, it can be argued that thriftiness and an exaggerated eagerness to pay back the debt lead to counterfinal results — instead of shrinking the debt mountain, it will in fact only make it bigger.

Wrong FocusA starving state reduces the economic activity level, incomes, investments, and tax revenues. Unemployment increases and unemployment payments grows — ultimately resulting in even higher public debt.

Today most mainstream economists are focusing on problems following on public debt being to high. Based on Keynes’ reasoning, I would rather say the focus ought to be on problems following on public debt being too low.

2 Comments

  1. Better precisely right than roughly wrong
    Comment on ‘Public debt and Keynes’ paradox of thrift’
    .
    Allais characterized the phenomenon Keynes as follows:
    “L’intuition de Keynes lui a fait sentir où se trouvaient les difficultés, mais son insuffisance logique ne lui a pas permis de résoudre les problèmes que son intuition lui avait fait entrevoir.” (1993, p. 70)
    .
    In other words:
    “Keynes’s intuition led him directly to the crucial difficulties but his logical shortcomings prevented the solution of the problems he uncovered.” (rough translation)
    .
    Keynes felt that there was something wrong with the classical theory of saving. But in the General Theory he ended up with the equality/identity of saving and investment:
    “Income = value of output = consumption + investment. Saving = income – consumption. Therefore saving = investment.” (1973, p. 63)
    .
    Unfortunately this apparently simply syllogism is false. Loosely speaking there is something wrong with profit, which is missing in the syllogism. The correct relationship is given with this formula:


    .
    This formula points the way to the consistent theory of aggregate demand, public debt, and debt deflation (see 2015).
    .
    The paradox of Keynesianism is that Keynes has never been recognized as the real great benefactor of the market economy.
    .
    In the pure consumption economy, the stabilization of aggregate demand directly benefits the business sector through loss prevention and indirectly stabilizes employment at the given level. Taken the process as a whole, the compensatory actions of the public households save the life of the business sector and redistribute income from non-savers to savers, that is, to those who have caused the chain reaction of problems in the first place. The whole process is a bit more complex but not essentially different in the general case of an investment economy. Saving not only reduces aggregate demand but is the exact complementary of loss. The theory of saving is false because the profit theory is false.
    .
    Egmont Kakarot-Handtke
    .
    References
    Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris:
    Presses Universitaires de France, 2nd edition.
    Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Aggregate
    Demand. SSRN Working Paper Series, 2564590: 1–22. URL http://papers.ssrn.
    com/sol3/papers.cfm?abstract_id=2564590.
    Keynes, J. M. (1973). The General Theory of Employment Interest and Money.
    The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke:
    Macmillan.

  2. The problem is saying that the public debt is too high, when in fact it is the private sector saving levels that are too high relative to their desired investment levels.

    Once you point out that cutting public debt necessarily means cutting private saving because we’re fully invested (or worse causing a further fall in investment) then the attitude changes.

    Why exactly are these people so against private saving that they want to slash into it. It doesn’t make any sense – other than they’ve completely got the wrong end of the stick.


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