Prices have gone up months ago on just about everything. Inflation has reached its highest level in decades. And because of the way we handle wires, we may make things worse.
“People tend to respond logically to gains but an emotional response to loss,” said Michael Fink, professor of wealth management at the American College of Financial Services, a Pennsylvania nonprofit that trains professionals.
Fink said this is because the loss is processed in the limbic or emotional part of the brain, and the gains are recorded in the prefrontal cortex, where cognitive behavior is processed.
Gas prices are a perfect example of how this works. Even at record highs, fuel costs still make up a much lower percentage of income, on average, than they have for most of the past.
But because of what’s known as the money illusion, “we tend to look at things in terms of dollars rather than purchasing power,” Fink said. If your salary has increased over the past decade, the total cost of gas is a smaller portion of your salary. But we tend to focus on the value of the dollar.”
When gas prices started to rise, Aradana Kejriwal tried not to take notice. They even changed gas stations. But when the packing price hit nearly three figures overnight, I switched from thinking about buying a Tesla to buying a Tesla. “I filled my fuel tank and it was $100.95. The moment I saw that, I thought, ‘You better get a Tesla soon.'”
Kejriwal, who lives in a suburb of Atlanta, knows better than to slip into this trap. As managing partner of Practical Investment Consulting and an expert in behavioral finance, she makes a living advising clients against doing things like buying a $50,000 car just because gas is over $4 a gallon.
There is evidence that rising costs are taking a heavy toll on our collective psyche. Earlier this month, a University of Michigan consumer survey found that Americans have felt no less confident about the economy’s current state — or where it’s headed — since 2011, just two years into the Great Recession.
Even Kejriwal has not been immune to one of the more common responses to economic uncertainty and endless reminders that prices keep rising. “On a daily basis, when you go out, it’s in your face,” she said. “And it becomes all about expected inflation rather than actual inflation.”
This is when the problem begins.
“When inflation is bad and people expect it to continue or get worse, they generally tend not to save money and try to buy durable goods before prices go up,” said George Lowenstein, professor of economics and psychology at Carnegie Mellon University.
Lowenstein refers to products such as appliances and equipment that are not frequently replaced. “To the extent that it increases demand relative to supply – that can exacerbate inflation.” With supply chains still in chaos and consumer cash and spending continuing to flow, says Lunstein, “this can be a self-reinforcing cycle.”
Economists already see this cycle running in a more diffuse way, with consumers hoarding basic commodities like toilet paper, baby formula and cat foodStore shelves are often left half-naked. This in turn causes other shoppers to practice what is known as availability bias. They begin to stock up in fear that the goods will not be available when they need them.
Kejriwal said getting consumers to change their spending behavior and think differently about how it contributes to higher prices requires a cultural shift as well as a behavioral change. “We’re a consumer-driven economy, and that’s one of the reasons we’re coming out of the Covid recession.”
This dependence on consumers to provide economic momentum, could now be his Achilles heel.
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