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How does spending, especially consumer spending help the economy to grow? Is this good in the long term?
October 14th, 2010 | 
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Question by Aaron S: How does spending, especially consumer spending help the economy to grow? Is this good in the long term?
I learned in economics class that saving money increases overall wealth. This ideas seems counter to today’s economics where consumer spending seems to be saving the economy. I don’t understand
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Answer by Darth Severus
spending keeps the money spinning.
you buy something, the seller uses that money to buy something else, that second seller again spends it and so on.
Each transaction leaves buyer better off (why would they buy stuff otherwise) and generates profit for the seller.
Know better? Leave your own answer in the comments!
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darth kind of has it,,,,,its not working that way now on account of the weak dollar……..lets put it this way, if 250 people buy furniture this weekend,this keeps people from losing thier jobs in the carolinas…….
It is true that saving money increases wealth. It is also true that consumer spending is what keeps the economy going. If people don’t save, there isn’t enough capital to invest, but if people don’t spend, then the goods that are produced can’t be sold. A healthy economy has the right balance between the two.
When you look at it in terms of the global economy, it gets more complicated. To simplify it and focus on one key issue, US consumers are spending too much, but Chinese consumers are saving too much. In the long run, this arrangement will probably work out very well for China and very bad for the US. In the short term though, these things are canceling each other out: US consumers are buying lots of goods from China, and Chinese banks are holding US assets.
Even in general, the benefits of savings to the economy are more long term. To prevent a slow down of the economy in the short term, an increase in consumer spending can help protect or create jobs, and more jobs leads to more spending and so on. That’s the theory anyway. To the extent that people just spend more on things imported from China, the job creation in the US is reduced.
Over the long term, the only thing that can make an economy grow in an increase in inputs. That is to say, an increase in productivity, labor, or capital.
When people say that consumer spending was responsible for growth, this is more of a business cycle issue. A growth in capital or productivity will result in more consumption down the road. If it happens to manifest itself in a particular quarter, it will look like growth was due to consumer spending.
The idea that stimulating consumption with tax cuts or government spending is a conclusion of Keynesian models of the macro economy. An important shortcoming of these models is that they are meant for the short term. In fact, a crucial assumption is that people don’t alter their savings rate. When looking at models of growth, the savings rate increases the capital stock, and grows the economy.