The Paradox of Global Thrift

This paper describes a paradox of global thrift. Consider a world in which interest rates are low and monetary policy is frequently constrained by the zero lower bound. Now imagine that governments implement prudential financial and fiscal policies, aiming at increasing national savings in good times to sustain aggregate demand and employment during busts. We show that these policies, while effective from the perspective of individual countries, might backfire if applied on a global scale. The reason is that prudential policies by booming countries generate a rise in the global supply of savings or, equivalently, a fall in global aggregate demand. In turn, weaker global aggregate demand exacerbates the recession in countries currently stuck in a liquidity trap. Therefore, paradoxically, the world might very well experience a fall in employment and output following the implementation of prudential policies.