Tuesday, September 28, 2010

It's Good to Spend

It's good to spend. It's official. Charlie Bean, deputy of Bank of England said. "What we're trying to do by our policy is encourage more spending," The current Bank of England policy of zero interest rates and quantitative easing is an unprecedented example of loose monetary policy.

I wonder how Charlie Bean feels about Government policy which seems intent on the opposite. - Make people spend less by cutting public spending?

The problem is that this recession shows even interest rates of 0.5% can be insufficient to encourage spending when you face a liquidity trap. People hoard cash as they are nervous over prospect of unemployment. It is this paradox of thrift that makes Central bankers need to try and encourage spending

Savers Should Run Down Savings

I was interested in this comment.
"I think it needs to be said that savers shouldn't necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit."
Firstly people may criticise the encouragement to run down savings. Certainly savers in the position of having to run down their capital will not be very happy. Especially given the relative high rate of inflation that is creating a negative real interest rate.

Paradox of Saving.

There is an irony in all this. The paradox of thrift is encouraging people to save rather than spend. Therefore the Central Bank and government try to boost demand. In theory low interest rates should encourage spending because savings give a lower return. However, this may not occur. If interest payments on savings are low, savers may feel the need to actually try harder to save. They have a target income from their savings. If this target income falls, they may actually increase their savings because they need to work harder.

In economics we say the income effect of lower interest rates is outweighing the substitution effect of lower return on savings.

The IMF offered an upbeat assessment of the UK economy. Predicting a return to growth of 2% in 2011 and 2012. The IMF also praised the government for implementing concrete plans to tackle the deficit. The IMF are optimistic that the spending cuts may just prove a short term drag on economic growth, and growth may emerge from other sectors of the economy


Antonia - Beauty Health Finance and Green Issues Editor said...


It's good to spend, even if you are flat broke and have no money, why not run up those credit cards bills, or if you have savings stashed away, why not eat into it, after all there is that credit card. Nothing like a bout of retail therapy, eh.


Who listens to this crew?

Anonymous said...

You still have to pay your bills, so you might as well take a loan and spend it smartly so you get yourself through to bad times and pay the loan back. That's what many economists propose for countries in recessions as well.

Or is it better to be without food and shelter, eh?

pratclif said...

all this is well; but what do you want people to buy? more of what? or what more? once they have paid their bills. Isn't the problem more with inequalities, thos who have small pays or who have no jobs; let them produce more to consume more....