What is the Paradox of Thrift?

• A. In bad times, increased saving reduces aggregate demand, slowing recovery
• B. Saving has no effect on demand
• C. Saving more in a recession always boosts growth
• D. Saving increases tax revenue automatically

Answer: (A)

Saving means choosing to postpone consumption. In a downturn, if many households try to save more at the same time, overall spending falls. With less demand for goods and services, firms cut production and lay off workers, which lowers income. Because saving is tied to income (saving roughly equals income minus consumption minus other outlays), the drop in income can offset or even erase the intended rise in saving. The economy ends up with weaker demand and slower recovery, and total saving may not rise as people hoped. This is the Paradox of Thrift: individual saving can, in aggregate, reduce economic activity and hinder recovery.