In this form it represents a prisoner's dilemma as saving is beneficial to each individual but disadvantageous to the general population.
This decreased demand causes a contraction of output, giving employers and employees lower income.
While the paradox of thrift was popularized by Keynes, and is often attributed to him,[3] it was stated by a number of others prior to Keynes, and the proposition that spending may help and saving may hurt an economy dates to antiquity; similar sentiments occur in the Bible verse: There is that scattereth, and yet increaseth; and there is that withholdeth more than is meet, but it tendeth to poverty.
[3][5][6][7] Keynes himself notes the appearance of the paradox in The Fable of the Bees: or, Private Vices, Publick Benefits (1714) by Bernard Mandeville, the title itself hinting at the paradox, and Keynes citing the passage: As this prudent economy, which some people call Saving, is in private families the most certain method to increase an estate, so some imagine that, whether a country be barren or fruitful, the same method if generally pursued (which they think practicable) will have the same effect upon a whole nation, and that, for example, the English might be much richer than they are, if they would be as frugal as some of their neighbours.
This, I think, is an error.Keynes suggests Adam Smith was referring to this passage when he wrote "What is prudence in the conduct of every private family can scarce be folly in that of a great Kingdom."
This ... is no idle paradox, but the strictest economic truth.Similar ideas were forwarded by William Trufant Foster and Waddill Catchings in the 1920s in The Dilemma of Thrift.
[9] Keynes distinguished between business activity/investment ("Enterprise") and savings ("Thrift") in his Treatise on Money (1930): ... mere abstinence is not enough by itself to build cities or drain fens.
The paradox of thrift formally can be well described as a circuit paradox using the terms of Balances Mechanics developed by the German economist Wolfgang Stützel (German: Saldenmechanik): It is about saving by cut of expenses, which always leads to a revenue surplus of the individual, so to saving of money.
[12] During April 2009, U.S. Federal Reserve Vice Chair Janet Yellen discussed the "Paradox of deleveraging" described by economist Hyman Minsky: "Once this massive credit crunch hit, it didn’t take long before we were in a recession.
And, financial institutions are shrinking assets to bolster capital and improve their chances of weathering the current storm.
Thus an accumulation of savings yields an increase in potential lending, which will lower interest rates and stimulate borrowing.
This is argued to occur in liquidity trap situations, when interest rates are at a zero lower bound (or near it) and savings still exceed investment demand.
[17][18][19] Hayek, and later Austrian School economists agree that if a population saves more money, total revenues for companies will decline,[citation needed] but they deny the assertion that lower revenues lead to lower economic growth, understanding that the additional savings are used to create more capital to increase production.
[citation needed] Some criticisms argue that using accumulated capital to increase production is an act which requires spending, and therefore the Austrian argument does not disprove the paradox.