by Dr. Roy Cordato
Senior Economist, Emeritas
Editor’s Note: This will be the final research brief for 2019. On behalf of the John Locke Foundation’s Research Division, I want to thank you for reading our work and wish everyone a Merry Christmas and happiest of holidays.
During the Christmas season, we spend money on gifts for friends and family, Christmas trees and ornaments, entertaining friends and neighbors, and preparing wonderful Yuletide meals. There are great reasons for allocating more of our income to spending during the Christmas season. But one reason that should never appear on this list is that it “boosts the economy.” While the old saw that extra spending during Christmas stimulates economic growth is repeated frequently during this time of year, it is a just one of many myths that have come out of Keynesian economics, which is the school of thought inspired by John Maynard Keynes, the most influential economist of the 20th century.
Behind Keynesian economics is the idea that spending, i.e., demand, spurs the economy to greater levels of economic growth. So, if people increased their spending during the Christmas season, it is particularly good for the economy. On the other hand, if spending lags during a particular Christmas season, it is viewed as harmful to the economy. Hence, people are encouraged to increase their spending during this time of year, not to show one’s appreciation for loved ones or magnify the Christmas spirit for those around you but to benefit the economy, increase GDP, provide employment opportunities, etc.
At first glance, this sounds reasonable. If we increase our spending, businesses will need to accommodate that increased demand. More of the products that we purchase must be produced, and more people will need to be hired. This is the way most people see it and the way most people who read business publications or watch CNBC or Fox Business Channel are led to believe the process works. And in a very narrow sense, the description is correct. The problem is the assumption behind the analysis. By and large, they assume that the additional money that people spend during the Christmas season, if not spent during the holidays, would remain in a vault in the attic or a shoebox under the bed. In other words, nothing else would be done with it. As silly as this sounds, it is a necessary assumption if the “increased spending spurs the economy” conclusion of Keynesian economics is to be taken seriously.
The fact is that money not spent in our local department stores or on Amazon.com at Christmastime (or any other time), it will go elsewhere. Leaving aside the possibility of charity, which doesn’t impact this analysis, we basically have two rational choices for our disposable income, and, from the perspective of the economy, one is not “better” than the other. Of course, one option is to spend the money, but the other, at least from the perspective of any rational decision-maker, is to save it, that is, to deposit it with a bank or financial institution. And certainly, the bank doesn’t hoard it. It uses it to make money, i.e., it lends it out to consumers that will buy a new car or house or an entrepreneur who wants to start or expand a business. The point is that all of this will contribute to growth in the economy, albeit in different sectors.
So how do the proponents of the “extra spending at Christmas boosts the economy” school of thought come to their conclusion? To understand this, we need to look at how old school Keynesian economics characterizes saving. It is described as a “leakage from aggregate demand.” In other words, along with taxes, Keynesians contend that it is money that “leaks out” of the economy. It just goes into banks and other financial institutions and remains there. Presumably, these institutions have no desire to make money with the money that’s being saved by lending it out or other means.
In fact, they claim that savings create a paradox for the economy. While saving might be good for the individual saver, it’s not good for the economy as a whole. In the jargon of Keynesian economics, this is called “the paradox of thrift.” The fact is that this approach defies not only sound economics but common sense. Money that isn’t spent is saved. And the money that is saved doesn’t sit in a vault at the bank but is lent to others who, in turn, spend it. In fact, if someone borrows money this Christmas to spend on a new car or other purchases, that borrowing is made possible by others who have already saved that money.
Spending extra amounts of money at Christmas is typically a good thing for a host of reasons, all of which are tied to the spirit of giving and celebration behind the spending. These are the reasons why we might want to alter our spending patterns during the Christmas season and put a greater proportion of our income into buying things as opposed to saving. But let’s not fall into the trap of thinking that when we increase our spending during the holidays, we are also doing our part to “stimulate the economy.” The line of reasoning that leads to this conclusion is faulty at best.
So, when making your spending decisions this holiday season, be generous and be joyful, but certainly don’t be deceived into thinking that you are or are not doing your part in stimulating the economy. Discredited economic thinking shouldn’t be part of the Christmas spirit.