Why in News? Keynesian economists argue that a rise in individuals’ savings, by reducing the amount of money that is spent on final goods and services, can in effect cause a significant fall in overall savings and investment.

What is the Paradox of Thrift? The paradox of thrift/ paradox of savings is an economic theory popularised by British economist John Maynard Keynes in his 1936 book The General Theory of Employment, Interest, and Money. It depicts that a rise in the savings rate of individuals can surprisingly cause a fall rather than a rise in the overall savings in an economy.

How is this Explained? Savings are invested by capitalists with the ultimate aim of selling their output in the form of final goods and services to consumers. Therefore, it might result in losses for capitalists and deter future investment if consumers do not spend enough money on the goods that capitalists bring to the market to sell.

What is the Significance of this Theory? It helped revive the circular flow model of the economy. It demonstrates how money flows from producers to workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular flow of money.

What are the Limitations of the Theory?

The circular flow model ignores the lesson of Say’s law of classical economics. Also, the theory ignores the potential for inflation or deflation. The paradox of thrift ignores the potential for saved income to be lent out by banks. When some individuals increase their savings, interest rates tend to fall, and banks make additional loans.