This morning I heard an economist on NPR talking about a Keynesian theory called the “Paradox of Thrift.”
During a recession, Krugman thinks that consumers freak out and start spending less. This reduces the revenues earned by firms from the sale of goods and services. But then this means firms have less money with which to hire factors of production (natural resources, labor hours, and capital equipment). That means the income earned by the owners of these items—i.e., everyone in the economy—goes down. But with less income, people in their role as consumers can’t spend as much on goods and services, so business receipts fall even further, and so on until the decentralized market economy crashes into a major depression. To repeat, Krugman thinks the free market can’t solve this problem, because individuals rationally respond to the onset of the crisis by increasing their cash balances, which only makes the crisis worse.
According to Krugman, in order to escape from this vicious cycle, the government must coax consumers to start spending again, perhaps by cutting interest rates or giving tax refunds. But sometimes (as in the present situation) those remedies are inadequate, and then it is the duty of the politicians to be the adults and spend tens of billions in borrowed money to do a Control-Alt-Delete on the economy.
This is probably something most people believe because they have never questioned it.
Read this article for a new perspective. Consumers Don’t Cause Recessions – Robert P. Murphy – Mises Daily.