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IAI Actuarial Core Principles · Business Economics · Main economic schools and their key features

Which statement best describes the Keynesian view of the 'paradox of thrift'?

The paradox of thrift says that when everyone saves more in a downturn, consumption and aggregate demand fall, reducing income and output, so total saving may not increase. It contrasts with the classical view that more saving automatically raises investment and growth.

  1. AIf all households try to save more during a downturn, aggregate demand falls, income falls, and total saving may not riseCorrect
  2. BHigher saving always raises investment through lower interest rates, boosting growth
  3. CThrift is irrational because people should consume all their income
  4. DSavings are determined only by the interest rate
  5. Saving reduces inflation but has no effect on output

Explanation

Keynes noted that what is prudent for an individual can be harmful in aggregate. Greater saving cuts consumption, lowering demand and income, which can leave total saving unchanged or lower. The classical loanable funds view in the second option is the opposing view.

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