I keep hearing that less spending hurts the economy. Why isn’t that true?
Spending or not spending (saving) are actions of freely acting people. They are nothing more than that. If people stop spending there is obviously a reason that they have chosen to do so. Either time preferences have fallen, people feel unsafe about the economy, say there’s a credit crisis, or people simply dont want to buy as many things as they used to.
But none of these things are bad because they always represent voluntary action, and since individuals always know what is best for them (or at least should be able to act on those preferences), it does not make sense to say that the people are acting in a way that is not in their best interests.
The claim that actions of voluntarly acting people can be bad for the economy can only start to make sense if one tries to claim that the economy is something more than merely the collection of choices and exchanges of individuals that compose it. If the economy were 2 people and one day they decided to make an exchange and on another decided to avoid trade, would it make sense to say that on the day trade was avoided the economy went into a recession? Or even suffered?
underconsumption is the key to economic growth. However, it is not the fault of the greedy american, the fed manipulates interest rates so that it does not accurately affect people’s time prefence (what they will gain in the future in order to delay current spending). You need savings of actual capital for sustainable growth, not just an increase in the money supply which is just claims on capital.
Think of a really small economy, just a couple of people. If everybody spends all their time to make/harvest food and they consume everything they make, they will not be able to work on anything else that could enrich them. Only if they consume less food than they produce will they be able to invest the time in building shelter since they no longer need to make food since they have saved. I know this is hard to translate to today’s modern economy but you need to accumulate real capital in order to invest in new things. When you just increase the money supply, the claims on capital, you don’t have any real capital and since the interest rates are artifically low you havemore demand for capital than exist so you always get asset bubbles. I think I might suck at explaining this but I hope it helps.
Savings in an economy directly transfer into some form of investment or loan to someone else, most of the time. In a normal economy, without fractional reserve banking, the only money you could borrow is that which someone else saves. Thus, the resources represented by the money which is saved/borrowed will never be misallocated, or using the better term, mal-invested.
However, we operate under a system of fractional reserve banking. If you go to a bank to borrow money today, you can be almost certain that money was created out of thin air. Now since money is a claim on resources (capital goods, consumer goods, and services) then what happens when more money is lent out than is saved is that a net drain on the economy’s resources occurs. If resources are consumed and invested faster than they are saved, then eventually the economy runs out (and a recession begins). Moreover, people’s wealth is confiscated by such a system because the perpetual creation of more money than goods and services will obviously lead to a devaluation of the currency, and hence people’s savings. In most cases, the interest you get on a saving’s account in a bank is far below inflation rates. You could call it negative real interest rates.
There are actually many layers to understanding this problem, and it ties in with very many aspects of our “modern” credit-driven economy. I recommend you read this: http://oneminute.rationalmind.net/business_cycles/ as it describes the situation quite well in a metaphorical manner.
I especially like the way that article labels central banks as “mischievous monkeys”.
‘under’-consumption has little effect on the economy and here’s why.
There are only three things you can do with your money:
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Spend
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Invest
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Dollar-under the mattress saving.
Investment, even under the Keynesian paradigm, is merely spending in capital goods; so investment is spending, just spending somewhere else. In the case of 3, the market will adjust. We know that markets clear; price equalizes supply and demand. 3 means less money in ciruclation which means deflation. The value of the currency will fall in order to compensate with increased plain saving. Thus, an increase in plain saving would bring about temporary deflation in all goods until the market is back in equilibrium again. Decreased spending/investment, only means deflation. It is important to note that what is claimed to be bad is not under-consumption in itself (the markets will adjust) but the changes in time preferences that lead to increased saving.
Does that mean we want to avoid increased plain saving? Not necessarily. Deflation is harmful for the businesses who have already entered into contracts with workers and the like. However, two points need to be made here. Firstly, people don’t radically change their saving patterns. Usually changes are slight, unless there is some kind of catastrophe, and in that case, withholding money serves the function of preventing future malinvestment. Of course, catastrophes like that won’t happen in a free market. Secondly, in the case that plain saving rates increase/decrease in a free market, businesses should be able to predict this and compensate while they make their contracts.
Another sort of abstracted way to think about this is that there are only a certain amount of goods in an economy at a given point in time. It doesn’t matter how much people spend, because there are only that many goods to be sold anyway. People could spend all their money and society wouldn’t be richer because at that moment in time, there are only a set number of goods. Only by increasing the amount of goods in an economy, through capitalist investment and increasing productivity, can real economic growth take place.
By underconsumption I meant at the individual level not IMMEDIATELY consuming everything that one produces so that you can invest.