Readers Question: when recession, people tend to save money in bank, because interest rise. the impact is..?(paradox of thrift),if the fiscal policy do not allow interest to rise and encourage people to spend, and govern collect more tax,which policy is beter?
- In a recession people tend to save money because there is a fall in confidence. If people expect to be made unemployed then you don’t want to spend and borrow, it is less risky to save.
- The paradox of thrift states that in a recession people are nervous so save more. This makes the recession worse because it causes a further fall in consumption. People think they are doing a good, responsible thing to save, but actually they are making the recession worse.
- In recessions, interest rates tend to fall. Because inflation is lower and Central Banks wish to try and stimulate the economy.
- The government will also try to use expansionary fiscal policy. This involves cutting taxes and increasing government spending. It will cause higher government borrowing (higher budget deficit) Expansionary fiscal policy may not work in the long run due to crowding out.
- In the US the authorities are trying both lower interest rates and lower taxes.
- The problem with lower interest rates is that it is causing a further devaluation of the dollar.
- Also lower interest rates may not actually help increase spending if confidence is low (e.g. because of falling house prices)
- There is a limit to how much the government can cut taxes because government borrowing is already quite high. US national debt is about 65% of GDP. In the recession this will definitely increase.
- Stock Markets fall because firms make less profit. There is also the danger firms may go out of business
5 comments ↓
I don’t get it. Why do we allow our selves to get like this.
But what happens to the balance of payments in a recession?
[...] Readers Question: But what happens to the balance of payments in a recession? (from: What happens in a recession) [...]
when there is a recession people are more likely to save than spending as rate of interests are rising..
recession also causes unemployment as firms face less demand for their goods and thus needing less workers to produce goods..demand for most goods and services fall..
there is also a fall in GDP(gross domestic product)
the standard of living also falls!!
This is pretty confusing. Saving is a function of income and both should decrease during a recession. The data usually show that saving at least stops increasing during a recession until the Fed increases the money supply. I think the confusion here is the fundamental difference between trying to “save money” when consuming and saving in an economic sense. During a recession, incomes decline, and because consumption and saving both come from income they should also both decline. People try to “save money” by consuming less but this is because they have less income or otherwise reduced wealth due to a stock market crash. They also have less money to save and this should be made clear. Total saving may increase in the mid-point of a recession but this is only due to the Fed’s actions. It’s also pretty stupid for someone to save their money during a recession only to be left with plenty of saving when things get better and their income increases. It’s much wiser for people to conduct precautionary saving during good times so they can use it during bad times.
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