WHEN BORROWING STOPS

And what if it does? Although consumers may not have kicked the borrowing habit for good, they give every indication that they're ready for a hiatus. And when consumers turn frugal, the entire economy shudders. A 1-percentage-point rise in the personal-savings rate works out to $100 billion in foregone spending, consulting firm McKinsey & Co. has calculated. That's bad news to makers of brand-name household goods, such as Procter & Gamble, which have lost sales to cheaper store brands. Carmakers also get dinged, because consumers stick with their old wheels longer, according to automotive researcher R.L. Polk & Co.

All too often, lower living standards follow close behind. That isn't the case for households whose incomes are rising, because they can pay down their debt while maintaining their accustomed level of consumption. But the millions of families who borrowed to supplement stagnant or shrinking incomes must choose between spending and reducing their debt. If they keep paying down debt, they'll postpone visits to the doctor, take fewer vacations, and wear the same clothes for another year. "In an idealized economic model," Wesleyan University economist Bill Craighead said, "interest rates, prices, and wages can adjust downward in such a way that demand remains steady enough to sustain economic activity." But in the real world, those adjustments don't happen immediately. Incomes fall faster than prices, and consumers, businesses, and government all tighten up on spending. "Without demand, there's no growth," he said, "and if there's no growth, living standards have to slip."

There's an upside to consumers leaving their credit cards in their wallets, however. Because so many consumer goods are imported, the U.S. trade deficit falls, as Americans take a pass on Korean widescreen TVs and Malaysian jeans: In July, it dropped by 13 percent to $45 billion, the federal government reported.

What remains to be seen is whether consumers' frugality will last beyond the current downturn. "Consumption is part of our DNA," said Jenny Darroch, a marketing professor at Claremont Graduate University in California. But consumers lose the urge to whip out the plastic, Darroch suggested, when they learn that Bank of America plans to lay off 30,000 and the U.S. Postal Service may dismiss 120,000 workers.

Among corporations, deleveraging is happening before our eyes. Moody's reported recently that the corporations it tracks were sitting on $1.2 trillion in cash at the end of 2010--money that could be used to develop new technologies, invest in promising start-ups, upgrade equipment, and hire workers. Instead, they're parking their money in safe short-term securities while they wait for business to pick up. In contrast, loans to small businesses fell by $2.5 billion this spring, according to federal estimates, although a new $30 billion federal lending program has loosened up the market a bit.

WASHINGTON'S QUANDARY

If consumers keep shedding their debt while businesses continue to hold--or are held--back, that leaves only one economic actor with enough clout to funnel cash into business's coffers and put people to work: the federal government. Or so the conventional--that is, Keynesian--textbooks say. Without government spending at a time of high unemployment and tight credit, Keynesian economists argue, business can't create jobs and people can't meet their expenses or pay down their debt. "Deficit reduction is the last thing we need to focus on," University of Texas economist James Galbraith said.

No, it's the first, counters Stanford University economist John Taylor, who worked for both Presidents Bush. Far from spurring private-sector demand, Obama's debt-financed programs--cash-for-clunkers, first-time homebuyers' tax credit, public-works spending--"lowered investment and consumption demand by increasing concern about the federal debt, another financial crisis, and threats of inflation or deflation," he wrote in The New York Times. Only when the government demonstrates "a clear commitment to America's living within its means," he argued, "will business regain the confidence to hire, expand, and invest."

Evidence in Taylor's favor is that hundreds of billions of federal dollars haven't restored a thriving economy, reassured business, or lowered unemployment much. In any case, given the prevailing political mood and the creation of a congressional super committee tasked with reducing the federal deficit, a slowdown in government borrowing seems inevitable. The conservatives' theory that less government intervention means a healthier economy will be put to the test.

If they're wrong, the consequences could be dire. In South Dakota and Michigan, some counties are replacing battered roads with gravel, because local governments can't afford to repave them. Cuts in federal and state aid have forced cities and towns across the country to sharply curtail social services and to lay off police officers, firefighters, and teachers.

"These cuts are completely unnecessary and destructive," Galbraith said. He called on governments to incur debt for undertakings that will pay dividends into the future--repairing roads and bridges, conducting research on alternative energy, and, above all, creating jobs.