Wednesday, December 14, 2011

How to increase your debts by saving more

When it comes to understanding the crisis, it's still hard to beat Krugman. By explaining IS-LM to a popular audience (including me) he's doing a great service, and I read today's blog post after seeing this chart (courtesy of Richard Koo), which shows that the UK government deficit is paralleled by a big increase in private saving.

According to IS-LM deficit reduction, unless it is counteracted by a dramatic increase in private borrowing (in a credit crunch?) will simply shrink GDP, because this is the way that desired savings get to match desired investment.

So if we really save hard enough, our incomes will shrink enough to make our savings as small as the paltry levels of investment we're currently suffering.

Look at the IS-LM graph long enough and a smaller deficit looks less appealing.