UNDERSTANDING how people's minds work when it comes to money is critical in shaping an economic stimulus plan that can produce real results, argues columnist James Surowiecki.
Surowiecki, a talented financial writer for The New Yorker, had a column titled "A Smarter Stimulus" in the magazine's Jan. 26 edition.
The topic was the economic stimulus package that is currently being debated in Congress. Part of the proposal is to give a tax credit worth $500 per person.
The Bush administration tried that in 2001 and last year with mixed results. It provided a small boost to the economy, but much of the money was saved or used to pay down debt.
President Obama has proposed paying out the $500 gradually by reducing people's paycheck withholdings. Critics say that will result in most people having just $40 or so more a month, which they say won't be enough to affect the economy.
Surowiecki argues just the opposite, and in doing so gives an interesting lesson on the psychology of money.
Most people make their spending decisions based on their current income, which is typically defined by the size of their paycheck, Surowiecki argues. People put windfalls in different "mental accounts." The bigger the windfall, the more likely it will be saved:
"If you want people to spend the money, you don't want to give them one big check, because that makes it more likely that they'll think of it as an increase in their wealth and save it. Instead, you want to give them small amounts over time."
It's been my observation that Surowiecki is correct. My first instinct when receiving the rebate check last year was to save it for a rainy day. But if I had $20 more in each biweekly paycheck, I'd probably be more likely to use it for a meal out or small purchase.
Surowiecki mentions in the column how people are more likely to spend casino winnings than money from an inheritance. The principle seems the same.
Casino winnings, though typically the result of luck, seem like money that you've earned. Thus you go out and blow it (unless you give it right back to the casino on the next hand). But an inheritance would seem like money to be used conservatively, which often means investing or saving.
Surowiecki concludes his column by urging lawmakers to craft policy that fits with how people act in reality. And for that reason he supports the Obama tax-credit distribution method.
"It's a policy that works with people as they are, rather than as we imagine they should be," he writes.
Staff reporter Bill Freehling writes this weekly column on business, personal finance and investing. He can be reached at 540/374-5405 or
Email: bfreehling@freelancestar.com.