We all have heard of the Paradox of Thrift which states that if everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. However there is reason to believe that another paradox of thrift might become prevalent over the next few years.
Since the finacial crisis interest rates of 1% or below have been evident in most industrialised countries and this has had severe ramifications for savers for the following reasons:
1. Low rates increase the liabilities of pension schemes as you need a much larger capital pot to buy a given level of income.
2. Deflation cuts the nominal incomes of those that have to fund future pensions, creating another potential gap between assests and liabilities. The consequences are clear for pension plans – more money will have to be put aside ie savings will have to go up.
3. Low interest rates makes it harder to accumulate a given capital sum as investment returns are lower. This means that more work needs to be done by the saver.
The Economist talks of a new cultural shift. We used to talk of borrow now, pay later but a more appropriate expression might be save now, rather than starve later. Another point to note is the numbers of people who do not have a pension plan in the UK:
47% of women of working age group
22% of adults aged between 55 and 64.
Low interest rates, which have the main aim of encouraging spending, could have the perverse effect of encouraging saving. Check out last week’s Economist article.