Frugality is Bad For the Economy
The concept of frugality has permeated mainstream personal finance in the past few years. That’s understandable, given the state of the economy. For many who have been personally affected, following the loss of income or a job, this frugality is a forced approach. People are looking for ways to save money because they have less of it to spend. Those of us who have been fans of the concept of frugality have been proud that the rest of the country is starting to jump on the bandwagon, re-affirming our outlook on personal finance.
Businesses are experiencing a forced frugality as well, particularly those whose business models rely on access to credit, a resource that all but vanished for some businesses during the credit crunch. As CNN Money pointed out recently, business aren’t hiring because they’ve learned how to survive on less. The employment numbers aren’t improving significantly, and unemployment forces more people to live on less, just like those businesses.
The economy won’t improve until businesses begin hiring and the public sentiment about the economy improves. It’s a feedback loop.
The primary tenets of frugality work well within an individual’s personal finance philosophy, but once the concept becomes a movement that spreads to a greater population and businesses, the economy can’t move. Here are some of the aspects of frugality that improve your own personal finance, but when practiced by the business world, keep the economy from growing at the pace we would like.
- Building up your emergency fund. Businesses like to call this their cash reserves. One of the first steps to creating a solid financial foundation for your family is fully funding a savings account to a level that could cover, for example, six months’ worth of expenses. This keeps cash liquid to help pay for necessary items during an unforeseen loss of income. If a company were to take the same approach, it would mean they’re not increasing return for shareholders by either investing in their business or by returning the cash to investors in the form of dividends.
- Spend less than you earn. This tenet is so basic that anyone who doesn’t follow this rule will, given enough time, eventually find themselves without a home or any other assets. Most of the time, the results are less drastic. Credit card balances increase and families become buried among high-interest debt. Many businesses rely on leverage for growth, and without access to credit and without a desire to over-extend, they can’t compete in the marketplace as well as they could otherwise.
There are other aspects of frugality that don’t particularly have a negative effect when adopted by businesses en masse. For example, smart shopping — finding the best discounts and the best value, not necessarily the cheapest option — benefits the economy overall, because vendors who provide the most efficient solutions will receive the most business.
On a personal level, let’s keep frugality alive as long as possible. The sooner businesses are willing to take on a little more risk, however, the sooner employment will improve, people will feel they have more money to spend, and the economy will start growing.
Article comments
The problem is not spending or saving. Neither should be made out to look evil. The problem is in creating excesses. Excess credit and no one stopping it caused the need for excess saving and frugality. No one wins when credit is handed out just to increase sales. Consumers and small businesses cannot survive without some level of frugality.
We don’t need frugality. We need spending to perk up the economy. It’s the Paradox of Thrift made popular by the economist, John Maynard Keynes. Over 70% of GDP (the economy) is driven by consumer spending…not consumer saving and frugality. Spending, no matter how unpopular it may be with PF bloggers, creates a trickle down of increased profits with business, which in turn results in more hiring etc.
Increased business with profits! Haha, but through what, credit? LOL So many people have no jobs are in debt it’s ridiculous. Getting homes they can’t afford. We are just getting the lesson that the depression era kids have been trying to teach us, but we got happy with credit, and didn’t listen.
There are around 3mill jobs that are unfilled, because employers so-called can’t fill them. They say they need skilled workers. They want the right fit for the jobs. Jobs being unfilled for 3 or more years. Seriously! These fools have never heard of job training?
So again who’s going to do all this spending. I don’t buy the huge spending is better for the economy.
I agree that being frugal is healthy for this country. Once we catch up – paying off debt- things will get better for the entire country. What we’re seeing is the natural order of things in motion. No amount of bail outs will change things. Let nature take it’s course and stop trying to correct it.
There needs to be a balance between being frugal with money and totally reckless with money. Recent times have shown that if either one gets way off balance it can create havoc in our daily lives.
Oh good grief – frugality is not bad for the economy – overspending, buying into things you don’t understand (bad mortgage anyone), maxed out credit cards, bankruptcy because of not being frugal, that is bad for the economy.
Those actions are actually positive for the economy short term. Long term they slow down the velocity of money and contribute to higher household debt, which will eventually drag down the economy. The accumulation of wealth and saving will slow down the velocity of money and be bad for the economy short term. It may seem counter-intuitive, but it makes sense if you look at it that way.
Now, while it may not stimulate the economy, my being frugal ensures that I’m able to live within my means and buy gifts for everybody in my family for christmas. I could live in a much nicer place but then I wouldn’t be able to spend all those hundreds of dollars on gifts. It’s a catch 22 for me. Nice place or nice gifts for people I love(whether it cash,gift cards or new toys).
I am all for frugal! In saying this, there is a great difference while being frugal in buying cheap and buying value. I think if people (in business too) looked at the value of their purchases rather than the bottom line, the savings would be bigger in the long run. This goes for hiring employees as well. If frugal businesses hired employees based on their long term value and not the cheapest payout, the savings-and loyalty, would be tremendous.
It would be swell if businesses would be frugal in areas aside from quantity of personnel.
My school district, for example, is taking on a massive energy reduction project and has saved about $70K since June. It’s not millions, but by the end of the school year, it’ll be probably 6-8 teachers’ worth of money.
Frugality isn’t what clobbered our economy. It was unsustainable debt, by the government and by consumers. Spending is only one facet of a healthy economy. Two other facets are saving and investing. Without capital from people who save, there will be no growth or hiring.
Right now, the personal savings rate is around %6, which is much healthier for the economy than the -1% which preceded the crisis. We are hardly frugal right now by historic standards. But, we are headed in the right direction.
Couldn’t agree more. Its a cycle, and if frugality continues than our economy will keep shrinking.
Thanks for this great post
A contraction in credit caused the recession. Those frugal businesses and individuals who had savings could keep on spending. That is good for the economy.
I agree with Dave and Rosa. Frugality would have a negative effect on the economy in the short run, but would provide for a more stable economy in the long run and sustainable growth. The growth we’ve had over the last two decades has been in the form of speculative asset bubbles caused by loose credit, that is not real growth. Credit can boost economic growth over the short run, but eventually that debt has to be repaid. Cheap credit forestalled that time for a while, but the consumer finally ran out of assets to borrow against. It’s debt repayment time and it will be for some time yet.
My employer is doing well because they were “frugal” (for a business) even in the boom times, and came into the recession with a strong cash account and not a lot of excess employees or property. Because of that and some luck, they’ve continued to hire through the recession.
Being frugal only when times are bad is like trying to time the stock market. It doesn’t help individuals very much, and if enough people do it the market lurches like a drunk on a bicycle. But following basic principles – not taking on too much debt, having a contingency plan for bad quarters, etc – means those companies, like those of us with big emergency funds and generally frugal spending habits – keep hiring, spending, and investing when everyone else is too broke.
I think our economy grew so fast in the past 20 years because of credit. People were buying things with money that they didn’t have. It overinflated the economy and caused it to finally come crashing down recently.
I think once people get to a certain comfort level with their finances, the economy will begin to rise once again.
Frugality in mass would hurt a growing economy and damage a weak one. But I believe only for a while. After a stabilizing period the economy would be on a firm foundation. Spending would be with retained earnings and not credit. Many businesses have a huge cash reserve and don’t need to borrow. They have good sales and keep expenses in check. It’s what we’re talking about here (frugality).
An economy with little or no debt would be so stable as to encourage spending, but only with cash. Any new business that wants to start would have to partner with investors and not borrow money.
Don’t forget, the tax structure is designed to reward spending and discourage investing. ie Buy a bigger house and write off part of your interest expense. On the other side, pay income tax, invest your money, and pay tax again on investment income. Additionally, the country needs to innovate and create more jobs. Frugallity is a small part of whether the economy will continue to grow. Also, we may be cutting back a bit, but our current savings rate at about 5% is still lower than that of many other countries. Thought provoking article, Flexo!
I’ve been frugal for over 10 years, and it’s great. I totally agree with you that frugality is hurting the economy!
While I’m still very frugal, but I have spent more money lately under the guise that I’m helping the economy (or is it really lifestyle inflation)… Mostly, I’ve been spending at the smaller stores and “mom and pop” businesses that really get hurt when the economy falls apart since they don’t have the deep pockets of a superstore like Walmart…
Frugality may be bad in the short run, but in the long run it is a very good thing. If more people had been frugal in the past, we would not have the economic mess that we have now. – On a different note, corporate America has record earnings now and it is sitting on a record pile of cash. Why should the maxed out consumer jeopardize his and her economic well-being when corporations are even tighter with cash than consumers are these days? Only the federal government and the Fed are spending cash right now, but they kind of make more cash if they need more which neither consumers nor corporations can do.
Blame it all on Sears and Roebuck: They introduced the masses to unsecured debt and their credit actions (started with little round disk with a number on it) was the genesis on VISA, MasterCard and every other usury driven adventure. Thrift was a forced way of life before debt became so accessible – now it just an option – and not a very attractive one at that. Although frugality may be extreme in some cases, living within your means (thrift) should never be discouraged by the government or anyone else.
I remember from my days in Economics that additional funds in the bank should drive interest rates lower (because of an increase in reserves by the banks) but I guess we are in a situation when rates CAN”T go any lower lol
So far QE2 has failed and the reverse has happened. Based upon Uncle Ben’s statement on 60 Min yesterday it sounds like QE3 is a possibility (no surprise though).
I am not against the “idea” of QE2, 3, or 9, but it is ridiculous to keep throwing money at a problem when it doesn’t seem to fix it.
I agree with you. Let’s not kill frugality for the sake of the economy. I actually wrote an article a while back arguing the opposite..that paying off consumer debt is good for the economy because you’ll have more dollars for actual stuff if you are debt free.
Here’s the article:
http://wp.me/p101OG-5c
If people had Emergency Funds, could afford the homes they were buying and put decent downpayments on them, the average joe would have been much better off right now. I believe there would have been fewer foreclosures and bankruptcies and the recession wouldn’t have gotten as crazy as it has.
Plus, I also like the idea that if you have 20-30% more money to buy stuff (because you’re not paying banks interest fees), you are promoting the manufacturing sector because you’re buying actual physical stuff. I work in the manufacturing sector, so I am biased towards keeping those jobs alive vs a banking job. I’m curious which of these two sectors employs more people per $1 spent.
Who says frugality is bad for the economy? What we had before was stupidity, and we had before a negative savings rate. It was primarily driven by the FED and now they want it done again (per no return on savings). They want to rise the animal spirits. They want you to spend, and acquire new debt.