Wednesday, February 29, 2012

Why paradoxes matter

"things that are normally good end up being bad." "people doing what they ought to do end up making the situation worse."

1- the paradox of thrift: if everyone saves at the same time during recession, they actually save less (because of decrease in consumption and economic growth).

2- the paradox of de-leveraging. when a company is concerned about defaulting on its obligations or concerned about rampant losses, it can use de-leveraging to lower its risk of default and mitigate its losses. but if everyone is shrinking and selling their assets simultaneously, the total value of the assets plunge, so everyone ends up in a worse financial state than they started.

3- the paradox of deflation: an individual company or worker can preserve a business or a job by accepting a lower price; but when everyone does it, we get debt deflation while our debt gets larger (which weighs on the economy). we also get deflationary expectations built into lending and investment decisions, which further depresses the economy. once you're in a deflationary trap, it's very hard to get out of it.