There’s something really important that european governments have to learn, The Paradox of Thrift. Free economics lessons for those "great politicians" who don’t know what to do now.
I’d like to explain it with the typical example, the Great Depression. We go back to the year 1929 when the economy is booming and it’s full employment. However, in October the stock market crashes and sends the business community into a panic. Reacting to the crisis, business cut back sharply on investment and production, and consumers do the same with consumption. Both reactions lead to a dramatically shift on spending, reducing aggregate demand.
What’s the irony here? In the return of save money, many households actually wind up saving less because their incomes are plummeting (reduction on aggregate demand’ effects) as the economy can’t further. This is the so-called paradox of thrift.
Let’s ask simple questions for simple people! What’s happening in America and Europe? Just that, cuts in spending. And that’s not good, at least now. I like to quote Keynes: “the boom, not the slump, is the time for austerity”.
Why should we trust Keynes, if he’s dead long time ago and the times are a changing? Easy, he’s right, and when a person is right we should trust him. If we cut spending now, some components of aggregate demand (mainly investment and consumption) will go down, then AD plummet even further. And that means less employment and consequently, unhappy people. And we don’t want that, don’t we?