Paradox of Thrift and Animal Spirits

Behold - the savings rate was 5% in January, the highest in 14 years: Savings Rate Hits 5%

This is both good news and bad news. Good in the sense that folks are getting real about fixing their horrid balance sheets (saving more, cutting down on debt). Bad - possibly very bad - in the sense that this increased savings will exacerbate the recession. See this very excellent and very wonky (warning!) discussion of "The Paradox of Thrift: http://www.econbrowser.com/archives/2009/02/the_paradox_of.html

The biggest issue here would seem to be how best to thread the needle - get folks to save more, but gradually and over time. It's all about the velocity of the change from spending to savings. If folks save too much too fast, you can kill growth dead as the economy cannot adjust quickly enough. This would appear to be happening as we speak. Makes me recall Best Buy's CEO telling analysts in November that he was seeing 'a seismic shift' in consumer spending, the likes of which the firm hadn't seen it its 42-year history. That includes the '73 and '82 recessions folks.

I worry a whole lot about a bunch of negative feedback loops that are fast emerging, and self-reinforcing, and are almost impossible for policy fixes - whether monetary or fiscal - to reverse.

A few such loops:

1. Consumers saving more = lower corporate profits = layoffs = consumers retrench further
2. Banks afraid to lend = less spending = lower profits = layoffs (see above)
3. Asian exports in free-fall = currency devaluations = trade wars = protectionism = contracted global commerce = depression (a la 1930s?)

There are many more, but for a really excellent analysis of such processes, many of which are more psychological than truly economic, look, as always, to Robert Shiller of Yale, and his recent discussions about "Animal Spirits"

Here's Dr Shiller in the WSJ recently - Robert J. Shiller: Animal Spirits Depend on Trust - WSJ.com (emphasis mine)

A critical aspect of animal spirits is trust, an emotional state that dismisses doubts about others. In talking about animal spirits, Keynes sought to convey the message that swings in confidence are not always logical. The business cycle is in good part driven by animal spirits. There are good times when people have substantial trust and associated feelings that contribute to an environment of confidence. They make decisions spontaneously. They believe instinctively that they will be successful, and they suspend their suspicions. As long as large groups of people remain trusting, people's somewhat rash, impulsive decision-making is not discovered....

In due course our animal spirits will once again turn positive, but we would rather that happen this year or the next rather than five or 10 years from now. There is only one way to speed this process: greatly expand governmental support of credit markets and pass a much larger fiscal stimulus plan than is now proposed.

Shiller wrote this in late January. Since then a too-small stimulus bill was passed, and government support of credit markets is still extremely murky and uncertain. Had he been polled in yesterday's Times, might he have stated that this may not end for another 5 or 10 years?

I rather suspect so