The paradox of thrift and other Keynesian conundrums

Can you stimulate an economy — shock it back into life like a defibrillator acting on an ailing heart? British economist John Maynard Keynes (1883-1946) famously said you could. Pour enough new money into the system via spending and tax cuts, he said, and the “animal spirits” of the moribund patient would revive and he would stagger back to life.

This is the story still told by Keynes’ modern-day followers, economists like Steve Fazzari, of Washington University in St. Louis, who explains some key Keynesian concepts in the recent edition of EconTalk (website, iTunes).

One such idea is the “paradox of thrift.” The paradox is that when one person decides to save, the economy as a whole experiences no net increase in savings. For example, if I decide to save money by forgoing my weekly night out at a restaurant, I have more money in the bank. But the restaurant owner (if he keeps his other spending constant) has less money in the bank. So the economy as a whole sees no net increase in savings.

EconTalk host Russ Roberts, an economist at George Mason University, is skeptical of the Keynesian story and challenges Fazzari with polite but probing questions. In the end they agree to disagree. And they also agree that the Obama administration’s planned economic stimulus package may serve as a real-life experiment, testing the validity of Keynes’ theories.

Related posts:
What would John Maynard do?

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