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The Paradox of Thrift « The Washington Independent

Has the economy scared you into cutting back on your spending, paying down your credit cards, getting your budget in order? Good for you, but bad for the country’s financial health, the Wall Street Journal points out today. Big-spending Americans have dramatically changed their habits, and economists expect the savings rate, which has dipped below zero in recent years, to rebound sharply.

Consider the Boise, Idaho couple profiled in the Journal story:

Rick and Noreen Capp recently reduced their credit-card debt, opened a savings account and stopped taking their two children to restaurants. Jessica and Alan Muir have started buying children’s clothes at steep markdowns, splitting bulk-food purchases with other families and gathering their firewood instead of buying it for $200 a cord.

Previously, the Capps counted on rising home values to take out money for cars, vacations, fiddle lessons for their daughter and $900 ski passes. That must have been some ski trip.

But like the Capps, Americans aren’t going down that road anymore. Economists expect the savings rate to increase to as much as 5 percent this year, the most dramatic reversal since World War II, the Journal said.

And what’s wrong with that? Haven’t consumers been told they need to be more responsible about debt and spending – the lesson of the financial crisis? Here’s the problem, the Journal explains:

Usually, frugality is good for individuals and for the economy. Savings serve as a reservoir of capital that can be used to finance investment, which helps raise a nation’s standard of living. But in a recession, increased saving — or its flip side, decreased spending — can exacerbate the economy’s woes. It’s what economists call the “paradox of thrift.”

There’s no easy answer here. It would be irresponsible for policymakers to urge people to go to the mall and spend again – that was the path President George W. Bush followed in 2001, and look where it got us. If politicians don’t take shortcuts, it’s true the recovery will take longer and be more painful than in the past – but consumers will come out of it in stronger shape financially. That will be worth more in the long run than artificially propping up the economy with overspending.

We’ll see, as the stimulus plan gets put together, which path President-elect Barack Obama and Congress will take this time around.

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