Point of View

April 23, 2014

Your Brain on Inflation
by Kerby Anderson


Brain researchers have found that we respond differently to higher prices with what they are calling a "money illusion." Researchers at California Institute of Technology and Stanford University reported that the higher the price tag that wine tasters saw on a bottle of wine, the more "pleasantness" they experienced from drinking it. In other words, their brain told them to expect a higher quality because they saw the higher price on the label.

Craig Smith in his book, The Great Withdrawal, uses this research to talk about all the ways this influences our economy. For example, the money illusion influences people to respond favorably to larger numeric quantities of money, even if the quantity has a lower purchasing power.

It can also explain how we have been reacting to inflation. The price of everything has been going up for decades. You could just as easily call the "money illusion" something like the "inflation illusion." In many ways we as individuals and as society as a whole have become addicted to inflation.

Economist Milton Freidman used to compare inflation to alcoholism. "When the alcoholic starts drinking," he said, "the good effects come first." But the next morning are the bad effects (hangover, etc.). He said that the "parallel with inflation is exact." The initial effects on a country seem good (business is brisk, people are happy). Increased spending starts to raise prices and workers find their paycheck doesn't go as far. When wages go up, we feel like we are moving up. Actually, we are just trying to stay even.

The solution to alcoholism and spending is to stop. That is why Craig Smith calls his book The Great Withdrawal. Just like the alcoholic, we have to go through withdrawal. This is hard for Americans to do since the "inflation illusion" makes you feel like you are doing better than you are. I think this explains why very few people seem too concerned about rising prices and increased government spending. Our brains are telling us that everything is getting better, even when its not.

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