One of the most pernicious and widespread economic fallacies is the belief that consumption is the key to a healthy economy. We hear this idea all the time in the popular press and casual conversation, particularly during economic downturns. People say things like, “Well, if folks would just start buying things again, the economy would pick up” or “If we could only get more money in the hands of consumers, we’d get out of this recession.” This belief in the power of consumption is also what has guided much of economic policy in the last couple of years, with its endless stream of stimulus packages.
This belief is an inheritance of misguided Keynesian thinking. Production, not consumption, is the source of wealth. If we want a healthy economy, we need to create the conditions under which producers can get on with the process of creating wealth for others to consume, and under which households and firms can engage in the saving necessary to finance that production.
Historically it was Keynesianism that brought the emphasis on consumption into economics. Before the Keynesian revolution the standard belief among economists was that production was the source of demand and that encouraging saving and production was the way to generate economic growth. This was more or less the correct understanding of Say’s Law of Markets.
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