Word of the Day: The Paradox of Thrift

Posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow.

Notes:

But, as pointed out by Steve Waldman:

• often forgotten hidden assumption in the "paradox of thrift"
  
• true: one person's spending is another person's income
• but: does not follow that an increase in saving translates to a decrease in aggregate income
• two kinds of spending: consumption and investment
• e.g. buying Ferrari vs. laying a subway line
  
• nearly all savings are actually spent on investment goods
• no "paradox of thrift":
• what is "saved" is really spent on current production of future capacity
• plenty of paychecks to go around
• no "fallacy of composition": individually and in aggregate, today's thrift lays the groundwork for tomorrow's abundant consumption
• but: for this to work out, two things must be true:
  
1. today's savings must be invested in projects that will actually generate future wealth
2. savers must believe they will retain a stake in the increased wealth commensurate with the size and wisdom of their investments
• we have a financial system in order to make these facts true