Economic Myth Busters - Spending vs. Saving

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There has been much talk recently about the benefits of spending during times of recession. The message that is often communicated is that spending causes growth and is good for the economy while saving does not cause growth. Even Nobel Laureate Economist Paul Krugman makes this claim...

If the money the government lays out doesn't get spent—if it just gets added to people's bank accounts or used to pay off debts—the plan will have failed.
—Paul Krugman (New York Times, Jan. 25, 2008)

Tobias Madden, an economist at the Minneapolis Federal Reserve, does a nice job of busting this myth. Madden says that saving does have economic benefits...

Saving provides an important source of capital to banks and companies. In particular, banks utilize consumer savings to make loans to individuals or companies, and public companies use consumer investments to build factories, hire new employees, research new products and so on. Saving drives all of the above. If an individual wants to take out a loan to buy a car, the bank can use the savings of consumers to make a loan to that individual. When a bank makes a loan, the person or business receiving the loan will spend the money, which is the secondary spending that takes place to aid economic growth. However, it may take time to make this investment and for the effects of the investment to roll through the economy.

Saving in the present creates stronger spending in the future. When consumers save, they earn interest on their savings and experience appreciation on their investments. When interest is received and profits are made, consumers have more income to spend than they had prior to the investment. When U.S. taxpayers received their tax rebate checks, spending them immediately may have had the greatest effect at the present; however, saving that check would have accrued interest and appreciation, creating greater spending power in the future.