February 11, 2008

Somebody Needs to Take a Refresher Course

IT SOMETIMES AMAZES me how personal-finance writers can get economic matters amazingly wrong, even if the personal finance advice they dispense is generally correct. Consider this gem of an observation about the economy from Suze Orman, the personal-finance columnist:

That's because if you're planning to use your Washington mini-windfall at the mall or a car dealership, you're playing into the government's theory that your spending will stimulate the economy and all will be well. Or at least all will be better.

I don't agree with that approach on any level. The economy isn't floundering because we aren't spending enough; it's floundering because we're spending too much, largely on credit. So do the opposite of what the government is hoping for -- it's far more important for people to boost their savings, not their spending.

(slap hand to forehead)

Uh, did Ms Orman skip economics in college or something? I mean, I'm sorry, but if consumer spending represents some 70 pc of the economy, and consumer spending falls for whatever reason, it will have a negative impact on the economy. If consumer spending rises, it will have a positive impact on the economy. Thus, giving money to consumers in the form of a temporary tax cut will boost the economy -- if that money is spent.

Along those lines, if people facing tough times (or the possibility of them) decide to cut back and start saving more, it will also have a negative impact on the economy. That's just Keynes' Paradox of Thrift.

Still, even if the economic analysis is half-baked, Ms Orman is right about the savings part. For most people, saving money through reducing their debts will help improve their financial situation.

Besides, one can argue that since the Government is borrowing this money for us, if everyone saved the cash it would have no negative impact on the economy, and perhaps a small positive effect. It's not as if people are saving on their own, thus crowding out money they would have spent. Instead the Government is giving them the means to save. In that regard, the Government is trying to head off the paradox of thrift -- and if spending continues because people feel more confident about their own affairs, then it might take some of the edge off of our current economic problems.

As for me, I plan a combination of spending and saving for my rebate check. I'm going to use $500 to make six' weeks worth of extra payments on my car. When it's paid off sometime this year, not having to make those payments will boost my income accordingly. As for the rest, I will go out for a nice steak dinner.

Posted by Benjamin Kepple at February 11, 2008 05:05 PM | TrackBack
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