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Wednesday, February 04, 2009

The paradox of thrift

NY Times economist Paul Krugman notes that the personal savings rate is rising - Americans are starting to save money again - but that incomes are falling faster, creating the thrift paradox:

Consumers are pulling back because they’ve realized that they’re too far in debt. The economy is shrinking in large part because consumers are pulling back. And the result, almost surely, is to leave household balance sheets worse than ever.

In other words, the debt to income ratio actually grows, because incomes are falling faster than spending.  What has to happen to improve the balance sheet (in the aggregate), is for incomes to rise and for people to sock away their excess earnings or pay down debt. 

Disclaimer: this is a macroeconomic problem and not an individual one.  Obviously if a household has had stable income and then cuts spending, they will save money.  What's happening is that layoffs and pay cuts are reducing income - overall - faster than Americans have reduced debt.

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