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A central tenet of Keynesian economics is that when any one individual saves instead of consumes, that there is no net saving in an economy.

Why do the Keynsians believe this? They argue that if Rizzo and his family decide that they are going to eat out less, and instead save a few dollars per week because they wish to save for a summer vacation, college education, or to pay my expected future tax bill increases, that while the savings for Rizzo increase, the savings of Nick’s Pizzeria decreases on a one for one basis. But to the Keynesians, the effect is less than zero, it is not benign. Though there is no change in net savings, Nick’s Pizzeria is beset by an unexpected drop in demand, which means Nick and his employees will have to reduce their consumption, and also their savings.

Of course, if this theory is correct, I don’t see that there are relevant policy implications. My major problem with the Keynesians is that they do. But “doing something” about this reduction in demand is based on the nonsensical premise that no decline in economic activity in any sector for any reason is permissible. Thus, when the personal computer gained in popularity, the savings of typewriter employees necessarily fell. Should we do something about the demand drop in typewriters? This sort of creative destruction is a feature of market economies – and the signals provided by profits and losses serve to direct resources into areas where we the people find them most valuable and direct resources away from where value is being destroyed.

But this thinking is wrongheaded for several other reasons. First, from a Keynesian perspective, it assumes that 100% of the money that Rizzo spends at Nicks is ultimately saved – how else could an increase in my savings be fully offset by a decrease in Nick’s savings? But we know that not to be true. Second, and more important, it ignores the role that relative prices play in directing individuals to make decisions. If Rizzo decides not to consume and instead wishes to save, those savings are immediately available as either current (unearned) consumption goods for people with a higher time preference, or are available as investment funds so that entrepreneurs can augment, increase and create a larger capital stock to increase consumption tomorrow. But I think the most important problem in this thinking is that is seems to be fixated on green pieces of paper and not what those things represent.

The only way Rizzo can eat a Pizza at Nick’s is if I have already earned the purchasing power to do such a thing. So, I build 10 widgets and am compensated for them in money, rather than in the goods and services that I want, for convenience. But suppose instead of money, I was compensated in 2 water bottles, 5 pens, 10 coffees and 20 candles for my effort. And when I eat pizza, I provide 5 pens and 10 candles to Nick in exchange for the pizza he creates. Now Nick has one less pizza, (or the pizza equivalent value of the resources used to create it for me) – but he does have 5 pens and 10 candles. When Rizzo decides to save rather than to eat pizza, he hangs on to his 5 pens and 10 candles. And while Nick does not have the candles and pens, he does have the pizza, or at least the value of the resources used to make pizza. Presumably this is worth LESS to him than the candles and pens, otherwise he would not have sold the pizza. However, does this mean that Nick’s savings goes down by 5 pens and 10 candles? NO!  At most it goes down by the difference in his marginal valuation of 5 pens and 10 candles minues to resources required to make the pizza. If Rizzo stops shopping there, Nick still has the resources required to make the pizza and he can save these.

But if Rizzo does not want to consume my pens and candles today, and wishes to do so tomorrow, he can save them by lending them to someone else who can use them to make even more candles and pens, or he can simply put them away until they are ready for use. In either case, the stock of Rizzo’s saving increases by 5 pens and 10 candles. The stock of Nick’s saving goes down (at most) only by the “surplus” he generated from the sale of the pizza. While it is possible that this surplus was as large as the value of 5 pens and 10 candles, it is not entirely plausible.

The key point is that when Rizzo decides to save his candles and pens he is not destroying that equivalent amount of savings from someone else. Because in order for someone else to obtain the candles and pens, they needed to produce something that I valued at least as much – and if they do not, then by not spending my pens and candles at the pizzeria, I am increasing wealth.

Another way to think about it is this, if the paradox of thrift is true, then why do we not have a corresponding “paradox of consumption?”

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