Most economists concur with the view that what keeps the economy going is consumption expenditure. Furthermore, it is generally held that spending rather than individual saving is the essential condition for production and prosperity.
Savings is seen to be detrimental to economic activity as it weakens the potential demand for goods and services.
In this framework of thinking, economic activity is depicted as a circular flow of money. Spending by one individual becomes part of the earnings of another individual, and spending by another individual becomes part of the first individual’s earnings.
If however, people become less confident about the future it is held they will cut back on their outlays and hoard more money. Therefore, once an individual spends less, this worsens the situation of some other individual, who in turn also cuts his spending.
A vicious circle emerges– the decline in people’s confidence causes them to spend less and to hoard more money. This lowers economic activity further, thereby causing people to hoard more etc. The cure for this, it is argued, is for the central bank to pump money.
By putting more cash in people’s hands, consumer confidence will increase, people will then spend more and the circular flow of money will reassert itself.
All this sounds very appealing and various surveys of business activity show that during a recession businesses emphasize the lack of consumer demand as the major factor behind their poor performances.
Notwithstanding this, can demand by itself generate economic growth? Furthermore, nothing is said here about goods and services – are we to take them for granted? Are they always around and all that is required is to have demand for them?
It would appear that what impedes economic prosperity is the scarcity of demand. However, is it possible for the general demand for goods and services to be scarce?
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