So we all start saving--what happens?

Most of America is in debt. What would happen if we all decided to forego all non-essential purchases and pay off debt? Suppose further that until all consumer debt was paid off, individuals no longer in debt still didn’t make more purchases but saved their money. (I would not consider housing, education, or per-person automobiles to fall in this category. But I do mean that if a person didn’t already own a house, they wouldn’t purchase one; just that existing mortgage wouldn’t count towards the debt in question being paid off.)

What would happen to the economy? Do different theories suggest different things? And what would be likely government responses?

Of course I’m no economist so I can’t really weigh in with expert opinion, but I imagine the result would be some short term crying from industry people then a change to how people are marketed to. Like any change it would hurt for a bit but the economy would adjust, and later when we’re all old and dying we’ll have some spare change to put back into the system with shuffleboard and bengay purchases.

The OP is a pretty decent synopsis of what happened in Japan for much of the 1990s. It was disastrous. If the scenario you describe were to happen we would have to assume it stemmed from a deep lack of faith in the future of the American economy. People tend to save more when the future is bleaker and more uncertain.

Stocks would tumble in value as less money is spent on products and services. The Fed would start to lower rates to attract more borrowing and thus more corporate spending. At first this would work, but as consumers continued not to buy, corporations would lower borrowing rates. Prices would fall to further entice spending, causing deflation. Deflation gives consumers further incentive to save instead of spend. If a new car costs $20,000 today, but you have a reasonable expectation that it will be $19,000 in six months you will wait to purchase.

In Japan the banks and financial institutions got into deep trouble by lending indiscriminately. Loan capital was easy to obtain, but demand was lax. As a consequence of too much supply and too little demand they made unwise loans to corporations that could not repay them. Many banks either went under, or were more often propped up artificially by the state. Bank scares further reduced consumer confidence.

The good news is that masses of people don’t act in a vaccum. It would be a good thing to see less debt in America and more savings. To have that happen without hurting the economy it would need to happen slowly. This would allow the economy to make gradual healthy adjustments, rather than enciting a deflationary spiral.

That being said, I am not an economist, so my analysis may be facile or mistaken in some places. My wife is an economist who reads the boards. I hope I am not being laughed at right now.