Is Not Spending Money Bad For The Economy?

Fairly regularly, a commenter on this site will chastise me and most of my visitors for being frugal, saying that hoarding all of your money is bad for the economy because we’re not spending it and keeping the money flowing. On the surface, this makes some sense – I’m holding onto money that I’m not spending at retailers so the retailers are doing worse business – but in the larger scale, a frugal person who is careful with their money is actually a boon for the economy. Let’s look at the reasons why.

First of all, a savings account is basically a loan to the bank. Instead of giving retailers money, you’re giving the bank money. In both cases, you get something back, but in that transaction, both businesses make money. If you give your money to a retailer for a product, they get to keep the markup. If you give your money to a bank, they use it to loan money to other people. So, if you put money in a savings account, you’re largely assisting the banking industry instead of the retail industry – you’re still helping the economy, just a different piece of it.

Continuing that train of thought, investing in a stock assists that company in doing business. A stock is issued by a company to help it raise money and grow in various ways. If you buy that stock, you’re helping the company by helping that stock maintain its value (which, in turn, represents the company’s value).

Let’s keep going:

If you buy a treasury note, you help out the federal government by lending them money for a while that they can use for various reasons.

If you start a new business with your saved money, you’re definitely boosting the local economy.

If you save ahead for a big purchase, you’re making that purchase faster than if you used credit to pay for it, which means that you have money to save or invest in other places.

If you reuse a product several times before throwing it away, you’re taking money you might have blown on replacement products at retailers and instead saving it at the bank.

What about economic cycles? Such cycles are caused by large-scale corporate behavior, not by individual choices. Companies always have ups and downs, and many of those ups and downs are tied together. For example, if 10,000 people decided to save up for a car instead of buying it on credit, it wouldn’t make much of a difference in the economy at all (some sectors would be up and others would be down, but the cash would still be out there), but if oil prices go up, that causes a domino effect in a bunch of different industries.

In short, the idea that not spending money is damaging to the economy is rather foolish. All you’re really doing by saving money and investing is moving money from one part of the economy to another part, not removing it all together.

Unless, of course, you’re going to bury it all in jars in the back yard, but that’s foolish in its own way.

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  1. The other side of this is that there are companies out there whose entire business is to make money off of you in such a way that they’re causing a bubble, which is bad for the economy. Credit card companies getting people to spend money they don’t have could encourage a bubble (the bad spenders are causing it – I won’t put the blame where its not due). So by shifting the timing of the flow from credit to cash we’re deflating a bubble, which helps the economy be more stable.

  2. Chris says:

    Except for executive compensation, which is often tied to stock, a company doesn’t benefit in any way after the initial offering of stock. That gets them a bundle of money, but after that they get no incremental money when stocks are bought and sold. Now, since the guys running the show also get lots of money from their stock options, it makes sense that they would try to keep the share price up, but that is personal interest rather than business interest.

  3. I never considered that saving money is just transferring business from the retail sector to the banking sector. I like that concept.

    We are a spender, consumer, debtor nation with advertisements reminding us daily about how we need to buy things in order to be happy. It is hard to blame people for having the idea that we need to keep spending. It is not easy to resist the barrage of advertisements and cheap credit that allows us to buy lots of things that make us feel good and give us self confidence.

    We just need to keep reading investment information to remind ourselves to delay some of that self gratification.

  4. Tim Wood says:

    If enough people change behavior, it does have economic impacts. BUT, the problem is not that you’re not doing your duty as a good merikun. The problem is the expectation that the public has to buy buy buy to keep the economy running.

    The current economic downturn is a direct result of the response to the last downturn. In essence, we pulled out of the internet and telecom crashes and the ripples from 911 by a flood of cheap money that made it easy for people to get into the housing market, cheap to pull “equity” out of houses and really really easy to go on spending sprees.

  5. paidtwice says:

    I have some jars in the backyard I need to go dig up…. darnit!

  6. Penny Nickel says:

    You’re right that saving and spending both keep money flowing through the economy, and it’s good to remember that.

    But what if we buy less and then choose to work less, rather than save more? That *does* decrease the amount of money flowing in the economy. Is it bad for the economy when parents live frugally in order to stay home with their kids? (Or when anyone chooses to work less?) Should we care?

  7. Getzly says:

    Re: “I never considered that saving money is just transferring business from the retail sector to the banking sector. I like that concept.”

    The banks can also loan out your money several times over, presumably to people who will be putting the money into the retail/housing sectors or businesses fueling their growth.

  8. Getzly says:

    @Penny Nickel-

    It may not boost the economy when people live frugally and work less, but shouldn’t the economy be a reflection of how people live their lives, not the other way around? “People first, money second.”

  9. ace says:

    Funny how the main measure of a country’s economic strength is GDP, which measures the value of goods and services produced. A better measure would be the net change in the value of its financial, material, natural, and human resources.

  10. ace says:

    @Chris: While it’s true that a company gets no money directly from its stock beyond its initial issue, the share price is still a matter of importance to the business on several levels. For one thing, a high share price facilitates growth. The prospect of easier borrowing and subsequent stock offerings that raise more money per share encourage the company to put its cash to full use, rather than, say, buy back outstanding shares at a low price.

  11. Penny Nickel says:

    @Getzly: Yeah, that’s what I believe, too, but I wanted to phrase it as a question to get people discussing!

  12. PJA says:

    It’s a bit of a stretch but replace “broken window” with “money wasted on something not needed” in the parable below…

    Parable of the broken window

    Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son happened to break a square of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact, that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—”It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”

    Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.

    Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.

    But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, “Stop there! your theory is confined to that which is seen; it takes no account of that which is not seen.”

    It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.

  13. CJ says:

    I don’t want to spend money on unnecessary things. BUT if I have a good IRA and a basic emergency savings account, I don’t want to invest unneeded money either. If the difference between my income and my needs is that much, why not reduce my income? If my budget allows it, I’d prefer to work fewer hours instead of earning money for no reason.

  14. Miguel says:

    Great post Trent! I wish you’d do more of these, maybe you could do an econ 101 category.

  15. Tim says:

    this is completely backwards logic. you cannot earn money on savings if the bank could not loan money to companies that earn money. companies earn money from consumption of goods and services. if there was no consumption of goods and services, you would earn nothing in savings and neither would the bank.

    second, stocks in companies. yes you are floating a loan to the company by buying a stock; however, if no one is consuming the company’s goods and/or services, then the company fails to exist.

    so you are thinking chicken or the egg, but it isn’t the same debate. the economy grows because people buy stuff and services. being frugal doesn’t mean that you aren’t buying, because you will buy something or at least your money will buy something inevitably. there is a difference between want and need purchases. there is nothing wrong with buying want as it fits within the framework of your values, budget, etc, etc.

    let’s not kid ourselves. not spending does in fact hurt the economy as well as your savings. people no buy, companies no income, companies no hire workers, people no have income, people no earn money on investments, companies no reason to sell stock or borrow money if no need for cash to invest in itself to produce goods that people no buy, banks no loan money if companies no need money since people no buy goods company would make, so banks no pay for people to deposit cash, so people no earn money from bank.

  16. MO says:

    The simple fact of the matter is that when you don’t have debt you HAVE, guess what?
    MORE MONEY!!! To spend probably.
    You are not paying all that interest to the bank.
    So, you can give money to the bank,(interest) or to a store, service, business etc instead.
    Which I would by far rather do, than give it to VISA, MC, Discover…….

  17. Laszlo says:

    I agree with the comments above that say lending to banks has more of an effect on borrowers than anything else. Sure, you and the bank shave off your share of the interest, but lending lubricates the economy tremendously by allowing others to buy homes, cars, educations or to start businesses.

    As for frugal living reducing your total economic contribution and consumption–so what? It’s your life. You should live it as you see fit. “The Economy” doesn’t register the time you spend with your son, the peace of mind you feel with no debts hanging over your head, or anything that matters, really.

    The GDP is an inadequate metric for something loosely correlated with happiness up to a certain point ($40,000/yr or so). Judging someone on whether or not their lifestyle has a negative impact on national GDP is ridiculous. Making the right choices to minimize your stress and maximize the happiness of you and your loved ones is all that matters.

  18. disavow says:

    It’s true that spending decisions by the blogging community, still in its potty-training years, would have little effect on the economy. But changes in patterns among the population at large can make a HUGE difference.

    Consumer spending is the entire reason why businesses invest in new ventures, research, and technology. If they don’t expect a positive return, investors simply won’t bother; rather than create something new, they’ll simply buy resources that already exist. Naturally, those resources become more expensive; their owners feel richer, but the gains are on paper only.

    Excessive saving caused the stock bubble preceding the Great Depression. It caused a boom in the Nikkei index at the same time that Japanese GDP growth slowed down. Globally high savings rates contributed to the Dot.com and real-estate bubbles. And even now, relatively high retirement savings (which aren’t included in personal savings rates figures) are making stock prices grow considerably faster than corporate earnings.

    The point is that while saved money would ideally be invested in some new product or service, often all it does is change hands without really creating anything. High consumer spending–somewhere around 2/3 of the U.S. economy–is necessary to make sure that companies have a *reason* to create.

    That doesn’t mean I agree with people who chastise Trent & Co. for saving; on average I stash about 40% of my income. I’m just saying that while naysayers are wrong about frugality in the blogging community, they’d have a point if it extended to society at large. Just because their sense of perspective is off doesn’t make them “foolish.”

  19. Victor says:

    Great in theory but you left out a few big things.

    1. The central banks around the world have recently injected 200 billion + money into the banking system. See – you’re savings is irrelevant to the grand scheme of things.

    2. Speaking of central banks, when you can print and create an infinite amount of “money” with printing presses or digital entries in a computer, the whole relevancy of your savings is muted.

    Spending is what drives the economy, keeping money in savings doesn’t really do much for anyone.

  20. Michel says:

    I agree with Laszlo.
    My life, my money, my choices. I have nothing to apologize for.

  21. brent says:

    “people no buy, companies no income, companies no hire workers, people no have income”

    This is completely wrong.

    It goes ‘people no buy, companies no income, company realise they selling wrong bluddy product, develop product that people DO buy, company gets income, company hires workers, yada yada yada.”

    Consumer = sucker.

    There’s no rule that you HAVE to buy something just because it’s for sale. It’s not MY fault that someone has entered the market place with ANY product, or group of products, which it isn’t in my best interests to buy.

    Need does not make a claim.

    Your need to sell your product entails no claim on my wallet.

    Frugal people still buy stuff, they just buy frugal things not flashy, wasteful things. Honestly, I think that the global economy could do with more trade in frugal, efficient, USEFUL things than flashy, useless trash that does nothing but look good and die young.

    Haven’t you got the message yet? This ISN’T GOING TO LAST.

  22. KCLau says:

    Economy is the system of production and distribution and consumption. Imagine if everyone just want to save the money without spending it. The bank will have too much money and nobody wants to borrow the monies because there’s no business when nobody is spending.

    The banks would have to stop taking in more deposit because it will put them out of business.

    But in the real world. This is not going to happen. No matter how hard we try to urge people to save money, there will be still merely 10% of the population do that.

  23. js says:

    And why should we care about the economy, if in the long run we’re all poorer (individually yes, but also collectively) because of our spending? If we used up all our natural resources making cheap junk that noone really wanted much anyway? And we did this because it was the only way we could find to employee 2 spouses from every family, working 40+ hour weeks each.

  24. m360 says:

    Those poor retail businesses. We aren’t putting money in their pockets as much. It’s not the economy frugal people are hurting, it’s the businesses that over charge for products we don’t need anyway. Do you really think someone who is making his own laundry soap is hurting the Tide Corp? There are many parts that make up the economy and as many opinions about what makes the economy turn and there are people. There are even some who argue that *war* fuels the economy. I can think of who benefits from it, but surely the economy where I live is the worst I’ve seen in a long time. I think there are some ignorant people out there looking to blame others for a crappy economy. In reality, the frugal people are only a very small percentage and there are some big spenders who make up for my frugal practices and everyone elses. I know I refuse to be held accountable for a bad economy and I wouldn’t even make a difference living on less than $900 a month.

  25. Ramblist says:

    This post reminds me of Keynes’ paradox of thrift, which surmises that something which is seemingly good for the individual, ie. saving, is not good for the economy at large. Unfortunately, in the current economic system, it is quite right to assume that spending is the best thing for everybody. The problem is that the money is being spent on crap that nobody needs.
    Look after yourself people, you can’t change what everybody else does.

  26. Otis says:

    The economy is like the water in a river. It flows from one reservoir to the next in a predictable pattern. The difference is how we make our dams. Do we simply say, “Hey, I love this flowing water! Why build a dam?” Then during drought die of thirst because we held nothing back. Or do we hold back all the water that comes into our reservoir letting nothing leave. That makes our own water stagnant and bad and leaves nothing for those downstream of our reservoir.

    The truth is that we all have to find some sort of balance. Hold back some water so that we can avoid a drought. Build up our dams (with knowledge) so that we can handle when rain does come. But still let some water flow because it’s good for everybody and prevents stagnation.

  27. BKD says:

    One thing that I don’t think was mentioned, is that even if we spend our money to fuel “our economy”, where is this money ultimately going? To some other country where tons of cheap stuff is made? Or to something made in the U.S. to support U.S. workers and U.S. resources…? It’s something else to consider when we spend, and let’s face it, we all have to spend a certain amount of money to buy the things we need (unless we are living a la “Walden”.)

  28. Adwoa says:

    I noticed no one mentioned the necessity of bottom, middle and top in a capitalist economy. Much of the “income” of those at the top is generated by their investments, not active employment. In order for them to literally live off of funds from investments, it is necessary for others to work at companies for them to invest in and deposit institutions to hold their funds and lend to other employees/consumers and companies. Yes, those without enough reserves to invest and live off of investment income are obligated to work for their income. They can only work for employers making enough profit to pay them. Employers can only make enough profit to pay it’s employees/consumers if those same employees/consumers and other employees/consumers and companies purchase its goods and services. Part of the probelm of our current economic bursting bubble is that as employees’/consumers’ real incomes continue to decline they actually have less to spend in this house of cards we call a market economy. If they can only afford to purchase the basics, there is necessarily less money flowing in the economy thereby doing weird things with the whole supply and demand theory.

    Folks, this is an extremely complex, artificial and self-propelled mechanism we humans have developed that we call “market economy.” I for one, have difficulty seeing its sustainability as natural resources are used up. Necessity driving invention has given way to invention driving necessity, which is otherwise termed “want.” Want is a flawed base upon which to build an economy because human want is never ending. It is a system that goes on and on and on creating its on slaves and slave masters. As long as humans can think, dream and desire (WANT), products will be created. Can anyone help me visualize a fix for what is an apparent problem to me. I too am on this merry-go-round spinning so fast I can’t jump off, lest I destroy myself. Market economy is the new feudalism.

  29. Liz says:

    I agree with Tim, and I believe that Trent’s analysis is completely wrong. What a pity that so many people here think that Trent makes sense. Not spending money would inevitably contract the economy and cause depression, when everyone becomes worse off. When goods and services are not consumed, business cease to produce profit and can no long afford to employ as many people. Also as demand decreases, each product has to absorb more costs, therefore driving up price. Consumers then will be worse off, as on one hand that they will face the bleak prospect of being redundancy, and on the other hand put up with the more expensive living costs. Also as investors, when businesses go burst, share prices go down, and investors lose out. So consumers, do not feel bad to spend money, everyone needs money to survive in this world. Do however exercise control when spending, be the master of money,but not its slave. Money is meant to bring us enjoyment of life, otherwise we may as well regress back to the stone age.

  30. wizofaus says:

    Trent is right – up to a point. That is, it’s clear that without any consumer spending, we would have no economy to speak of. But in general, producing useless gadgets or entertainment devices is not creating wealth, hence not contributing to the economy in any meaningful way. Money kept in a bank account, sensibly invested in the stockmarket, or used to fund your own wealth creation projects will always, in the long run, be more beneficial to the economy than money spent on consumer items that don’t improve your wealth-creation abilities.
    Indeed, most people that do become very wealthy do it by a certain amount of scrimping and saving…essentially by deferring rewards. Once you are that wealthy, then you can afford to spend money on quality goods that are well made, will last longer, and bring far more satisfaction than cheap mass-produced items.

  31. Liz says:

    Trent is wrong, as the scarcity mentality of the general public has already pushed the US economy into recession, the share market cannot produce satisfying return until recession ends and people start spending money again. Money is meant to be spent, not meant to be kept.

  32. Christina says:

    i have really bad money issues. one day i will get money for something i did and the next day i will have spent it on something stupid.

  33. SBT says:

    Liz,

    It seems to me that the “scarcity mentality” is caused by problems of real scarcity. When companies pay their chief executives 400 times what their average worker makes, and real wages, adjusted for inflation, are stagnant to falling, people naturally are experiencing actual scarcity. The generation coming into the workforce today is perhaps the first generation since the Great Depression where children are likely to be in a worse economic position overall than their parents were.

    Henry Ford figured out a long time ago that if he wanted to mass produce and sell lots of cars, he needed to pay his workers enough to be able to afford cars. He substantially raised his workers’ wages. If corporate America were really concerned about selling more product, and sustaining the world economy,they would be raising wages worldwide, rather than enriching themselves at the expense of their workers. They do depend on the masses to buy their products. It should not be the government’s job to throw a little money at people to stimulate the economy. It should be evident that people will not buy what they can’t afford for long before they go broke. And broke people can’t buy much. When will they realize that they are shooting themselves in the foot by hurting their workers. Mink coats don’t trickle down.

  34. clayton says:

    I agree with SBT who wrote on September 6th, 2008 (comment #33) and also many others who have written here.

    I think the problem rests with a combination of two major points.

    1) The USA is a country of waste and instant gratification. We want things because others have them or because they look, as my girlfriend says, “pretty”. Whatever pumps the happy chemicals into our brains, we want in the USA. However, that is the real problem. Instead of investing in technology and items that make life WORK at the most efficient level, we’re running around spending money on the flavor of the week items because our neighbor has what we don’t.

    We love our independence in the USA but we’re all so dependent on the wants and desires of others it’s pathetic.

    2)Corporate greed. Henry Ford had a revolutionary idea when he realized that paying workers enough to buy the product they create is how it really ought to be. The skills required to make something should be of equal value to the product that is created, not less. Simple as that.

  35. jreply says:

    It is silly to say that an employer needs to pay his workers enough to buy the product. That would mean toothpick factories would pay their workers enough to buy toothpicks, apple farms would pay their help enough to buy apples, and shipyards would pay their workers enough to buy ships. Lexus would pay employees enough to buy Lexus cars while Ford would pay employees doing the same work just enough to buy Escorts. This is not how it works.

    Employers pay their workers their estimated marginal product – the extra value their labor
    adds to the product given the capital (machinery, etc.) the workplace uses.

    Henry Ford did NOT use the reasoning that SBT (and many others) suggest. That wouldn’t make any sense because his workers aren’t buying a new car every year and they were only a small portion of his market. If he wanted to entice them to buy Fords, it would be cheaper for him to give them a discount – which is what car companies do – NOT pay them the price of the car.

    Please investigate economics and the topics of marginal cost.

  36. jreply says:

    Many countries with very high savings rates are growing very fast. That’s because saving gives us more to invest in capital goods – factories, machines, etc. In China, the savings rate is estimated to be over 40%. According to those people who believe in the paradox of thrift, China should be stagnating. Saving is at least an economic virtue, not an economic vice.

    The 1920′s bubble and the Japanese bubble were artificial booms caused by central banks printing too much money. People were savings but nowhere near enough to support these giant investment booms. Savings don’t cause bubbles, printing presses do.

  37. Scott says:

    What you don’t get is if there is no spending companies do not hire and shut the doors! This so called problem is false! Wake up people! Casino’s a packed on week days during the day so is Walmart and every resterant I have seen! What is hurting us is small businesses as well as large ones are shutting the doors out of fear! No advertising! No advertising and the business fails! The fear part is posed on us by the government to gain more government control! The American people have been brain washed. Yes I know companies and banks have screwed themselves and us by doing things they should not but the main problem is no JOBS…no spending or cut back spending…NO ADVERTISING!……Here is case in point: Our Desoto County news paper have laid off ALL the classified dept and I was told “People aren’t advertising anymore. so out of the whole newspaper 1/4th of a page is our classified section. People have bought into the fear and now look at us. We can recover but we have to wake up first. Companies need to hire, advertise and we need to go back to work, save yes….spend yes…do all of the things we use to do. Support small businesses even more!

  38. steve says:

    Who cares about the economy, take care of yourself! The “economy” doesn’t care about you.

    Or, do the thing of encouraging others to spend, but saving yourself. When others spend on your goods it is good for you. This is basically what all advertising encourages–it encourages people to spend what they have on a company’s products, for the good of the company–and if the customers benefit or not is not necessarily part of the equation.

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