Question

Thriftiness is usually regarded as a virtue and, hence, desirable. But Keynes argued that saving becomes a vice in the economies where there is excess production capacity and unemployment. This is known as ‘paradox of thrift’. How would you explain paradox of thrift?

Answer 1

The paradox of thrift describes a situation where efforts by individuals in a country to increase their savings can actually lead to a decline in the overall level of savings. Keynes addressed this paradox in his General Theory, explaining that when one person saves more, they spend less, which means less income for someone else since one person’s spending is another person’s income. Consequently, as one individual’s savings increase, another’s income and savings may decrease.

This sequence unfolds as:

Higher saving (thriftiness) → lower consumption spending → reduced aggregate demand → decreased output → decline in employment → drop in income → fall in actual savings.

Therefore, in a depressed or recessionary economy—where production capacity is underutilised due to weak aggregate demand—increased thriftiness can lead to lower income and reduced actual savings, rather than the intended increase.