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The Paradox of Thrift - Case Study Example

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The author of the current case study "The Paradox of Thrift" states that in John Maynard Keynes's 1936 groundbreaking book titled The General Theory of Employment, Interest, and Money Keynes parted ways with the classical view of economics and investment by putting forward the Paradox of Thrift…
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Download file to see previous pages The level of investment determines the level of saving and not the other way around (Michl 2002, p.43). The point has been argued for the next 70 years and both theories have at times fallen in and out of favour.
Thomas Palley of the AFL-CIO wrote in a 1996 paper that, "The view that saving causes investment is widely identified with classical macroeconomics, while the view that investment causes saving is widely identified with Keynesian macroeconomics. However, deeper inspection reveals that both theoretical perspectives are capable of producing bidirectional causality, and this limits the usefulness of theory for resolving this crucial matter" (p.5). Supply-side economics has run headlong into the demand side theories and have resulted in numerous, and yet valid, academic arguments on both sides. According to theory, "...saving can never be different from intended investment, in equilibrium" (McCain 2007). The Paradox of Thrift is one explanation, though not the only one, of how savings can influence an economy's production and increase the unemployment rate.
Supply-side economics maintains that the marginal tax rate, the rate at which the next dollar earned is taxed, directly influences people's propensity to work, save, and invest (Gwartney 2002). By reducing the marginal tax rate investors are stimulated to invest in a business that may be too risky under a higher tax rate. Lower tax rates may spur people to work harder or longer hours and save their money. Indeed, the tax rate has often been used by governments to stimulate investment. According to Gwartney (2002), "Of eighty-six countries with a personal income tax, fifty-five reduced their top marginal tax rate during the 1985-90 period, while only two (Luxembourg and Lebanon) increased their top rate. Countries that substantially reduced their top marginal tax rates include Australia, Brazil, France, Italy, Japan, New Zealand, Sweden, and the United Kingdom". Many critics saw these deep tax cuts as a bonanza for the rich and argued that the increased tax revenues during this period were simply the result of an increase in demand. However, during this period of tax cuts in the United States, "...the income tax revenue collected from the top 10 per cent of earners rose from $150.6 billion in 1981 to $199.8 billion in 1988, an increase of 32.7 per cent" (Gwartney 2002). It can be inferred that a lower rate and increased revenue were the results of a massive increase in wealth for the top 10% that came from capital investment. It would seem that supply-side economics had proven itself once and for all.
Demand-side theorists continued to point to the Paradox of Thrift and its effect on consumption and production. Advocates of demand-side economics contend that "...a decrease in spending leads to a decrease in employment, which leads to a further decrease in spending, which leads to a further decrease in employment, which leads to a yet further decrease in spending, and so on" (Thies, 1997). Some economists contend that corporate cost-cutting is a path to a 'corporate paradox of thrift' which could lead to massive layoffs and firings' (Shostik 2002). ...Download file to see next pages Read More
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