Debunk away!
I’ll give it a shot.
The paradox of thrift can be summarized as this: if everyone saves more, aggregate demand drops, production declines, layoffs ensue, and everyone is worse off because of it.
There are a number of problems with using the paradox of thrift as a basis for economic policy.
- It makes the assumption that a decrease in aggregate demand is always and everywhere a bad thing. Let’s look at a real world scenario. Let’s say that everyone agrees that tulips are the next big thing. People start buying tulips like crazy. Everyone is employed growing and selling tulips. Tulip mania results. For a while, the fact that tulips keep going up in price drives enough speculation to keep prices going up. Eventually, though, even the speculative demand is saturated. The bubble bursts, and mass unemployment results. A lot of people who could be growing and selling tulips are not growing and selling tulips. Is it really a bad thing that our tulip production capacity is underutilized? I would argue that the focus of the economy on tulips was the problem, not the underutilized tulip production capacity.
- Let’s look at the flip-side: is it possible for demand to be too great? I would argue yes: If everyone is spending more than they are making, this is probably a bad thing. It’s certainly not sustainable. If demand can be too great, then maybe it’s possible for decreased demand to be a good thing.
- The treatment of everyone is quite uniform. Some people are better off after a downturn. There are counter-cyclical assets (guns, safes, bankruptcy attorneys). Even some people in pro-cyclical industries are going to be better off after this downturn if they save. Employment never drops to zero. While aggregate earnings might drop, some incomes will actually rise.
- The framing of the problem is quite static. Presumably people are saving for a number of reasons. These reasons might be irrational fear, or they might be a variety of rational reasons. The rational reasons might be anticipation of a job loss or simply that nothing appears to be a worthwhile investment or consumption target. If someone invents the next big thing, investment and consumption might rise for rational reasons.
Like most Keynesian problems, the Paradox of Thrift is obsessed with full employment. As others have pointed out, there are problems with this obsession. It’s possible to attack unemployment without fixing the underlying structural problems with the economy. That’s probably not the best for the long run.
Krugman claims that our problem is insufficient demand. I don’t think that the claim is adequately backed by reasoning or facts. The fact that we have productive capacity that is unused is not sufficient to say that aggregate demand is automatically wrong. I’m not saying that it’s automatically right, either.
As far as Krugman’s specific comments in the actual video, some of them are factually incorrect. Particularly, his comments on nationalization and receivership. He makes some absolute claims (such as saying that the FDIC doesn’t close a failed bank … this is one of the three officially stated options, though it still involves making the depositors whole) that are incorrect, but they aren’t important.
