When bad times hit, people save more, which is good individually. But it hurts the overall economy, because when people spend less the weakened economy declines more.
It's called the paradox of thrift.
So what should Americans do: spend or save?
Consumers cut back 1 percent
It's clear what they are doing: They're cutting spending -- by about 1 percent in December, according to Commerce Department figures released Monday. That's the sixth straight monthly slide in consumer expenditures and the biggest decline since 1974.
The silver lining is that Americans are beginning to save again. Despite an 0.24 percent decline in their incomes between November and December, they still boosted their savings rate from 2.8 to 3.6 percent over the same period.
If that rate held annually, it would be the highest savings rate since 1998 and far better than the record low of 0.4 percent in 2005.
A cut that rivals stimulus?
Here's the sobering news: If December's savings rate holds for all of 2009, then the 3.2 percentage point rise (0.4 percent to 3.6 percent) would outdo any increase in the run-up to previous postwar recessions. Even a 1 percent drop from last year would mean consumers spending some $200 billion less in 2009 at a time when retailers are already reeling from a plunge in sales.
The savings rate is so low that a return to more normal levels of, say, 7 percent in 1990 would pull even more money out of the economy. Everything else being equal, it would mean another $700 billion cut in spending. That would amount to $900 billion less in consumer expenditures -- roughly the amount of stimulus that the Obama administration and Congress are trying to pump back into the economy using tax dollars.
So the future of the new economy lies in the hands of individual Americans who are conflicted.
First, fix your finances
Those who have too much debt are beginning to pare debt and boost savings. And they should. The long-term health of their own balance sheet demands it, even though it hurts the economy in the short term.
"Save and pay down debt, the safest investment with the highest return," Allen Sinai, president of the economics firm Decision Economics, writes in an e-mail. "Take on new credit only if absolutely necessary."
Those Americans who have saved all this time can loosen their purse strings. It's not necessarily a moral obligation. But there are great deals to be had out there.