Saturday, 7 February 2009

Stimulus, Savings and Cruel Ironies

Lots of discussion regarding the likely impact of the Obama stimulus package mentions the Keynesian multiplier effect.
In very simple terms the multiplier effect can be quantified as 1/marginal propensity to save. It follows that the higher the percentage that goes into the denominator (the marginal propensity to save) the lower the actual multiplier value

The effectiveness of any stimulus has to reckon with the fact that there is a trend developing - as evidenced by recent reports regarding consumer credit contraction - that people are saving more in the Keynesian sense which is that less of their income is being used on current consumption.

The cruel irony or paradox is that the virtue of thrift will diminish the impact of the stimulus package. It will prolong the recession but arguably on the other side of this recession the US economy may have the benefit of a larger pool of genuine savings again.
The even more cruel irony is that this new private pool of savings would be at great risk of evaporation if the re-inflation scenarios being touted by many come to pass.
But as readers who have seen the "Life of Brian" will recall we should perhaps take our inspiration from the song "Always Look on the Bright Side of Life"

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