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The Paradox of Thrift

As the contagion of coronavirus spreads through each country, governments are reducing interest rates and preparing to inject stimulus funding into the economy. The reason they are doing this is because they understand that in times of crisis, companies and people hold on to their cash. Its known as the paradox of thrift.

By holding on to their cash, they remove cashflow from the economy, which is its lifeblood. No cash flowing, and the economy has a heart attack. Demand for goods and services falls, and so production reduces, and so on. According to Keynes, recessions are caused by the fall in aggregate demand.

Stimulus

Stimulus is an injection of cash or an incentive to spend through tax relief, in the hope that people will spend it, keeping the companies alive, and people in employment. If people aren’t working, then tax revenues fall, and those people require government assistance, a double whammy.

The paradox of thrift means that while coronavirus is having a negative impact on trade, transport and travel, being thrifty amplifies the problem for the economy by changing normal spending habits, and reducing the available cash. Businesses downsize by letting employees go, or businesses go broke, which compounds the economic impact of the virus. Small to medium sized businesses employ over 65% of the workforce in Australia.

The government’s role is to restore confidence, because despite the use of algorithms and AI, the market still runs on emotions. People spend when they are confident and conserve when they aren’t.

A few positives for consumers and businesses include the reduction in interest rates, the reduction in the oil price, which should eventually reach the bowsers, and Australians choosing to holiday at home as borders begin to shut to travellers in an effort to contain the spread of the virus.

Just keep in mind the impact of increased savings – it might just have the opposite effect on the economy that you were hoping for.

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