The Paradox Of Thrift

28th September 09 – The paradox of thrift

“Any attempt to reduce consumption is likely to push down on output and hence household incomes. That could actually make it harder for households to increase their savings – known as the paradox of thrift.”

This statement is contained within the latest Quarterly Bulletin issued by the Bank of England. Because consumer spending accounts for two-thirds of total spending in the UK, household decisions on whether to spend or save have a major impact on the economic outlook in this, hopefully, emergence from the credit crisis.

The dichotomy is expressed by the Bank by saying that even if households saved as much as 10% of income, it would take nine years to bring wealth to the average of the last 20 years. That really is quite some paradox considering that spending led to the crisis in the first place. The two big factors quoted as most likely to lead to a reluctance to spend again at previous levels are:-

• Credit conditions remaining tight

• Job insecurity

The B of E’s bulletin does, however, find some helpful signs. Most financial asset prices have continued to increase over the third quarter of 2009 and conditions in bank funding markets have improved. Also, sentiment has allowed analysts to revise upwards their expectations for short-term corporate earnings. Equity prices continue to rise and as at today the FTSE is sitting at 5,133 a twelve month peak.

There is one final paradox. In the period July 24 to August 4th the B of E did not buy any corporate bonds after receiving no offers in five consecutive auctions. No sellers means no QE. No QE must mean there is enough dosh out there somewhere. Surely that is a trigger point. Even so, many people will be reluctant to spend again and not least the army of public workers.