Spending (alone) Does Not Stimulate the Economy

Matt Perman from Wha’ts Best Next recently wrote an outstanding article on why spending alone does not stimulate the economy.  Here’s an excerpt.

…it is pretty easy to see the fallacy in the idea that consumer spending stimulates the economy. Here’s a short example to show why.

Let’s say that the “economy” of my family is in bad shape. Do my wife and I conclude that it’s “time to go spend more money” so that we can get things back on track? Clearly not. That would be a devastating course of action. Instead, we would embark on two strategies: (1) save more and (2) earn more money (= produce more goods and services of value).

The same holds true when we think of the economy as a whole. Nothing changes simply by increasing the number of people in the predicament.

To illustrate this, let’s say that there were 300 people in my family and we were running out of food. Would that change anything about the need for our fundamental strategy of saving more and producing more? No. We’d have more people to produce things, which would be a benefit, but nobody would say “hey, we’re short on food, so let’s start eating more!”

Does anything change if we extend this out to 3,000 people? Or 300,000? Or 300,000,000? Not at all. The reason is that there is still a finite amount of resources. We cannot invent economic goods out of thin air.

I’m not saying that there is no role for spending in the economy. I’m saying that saving and earning must come first. You cannot spend unless you have something to spend.

You can find the rest of the article here.

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March 25 2009 08:00 am | Blog

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