Saturday, August 2, 2008

How I Spent My Stimulus Check

When I got a letter telling me to expect a $600. stimulus check, I became a bit sceptical. I had registered for the refund to be automatically deposited to my account, so I did not expect to receive either the notification or the check by mail.

At first I thought that it must be one of those Nigerian schemes involving the putatively wealthy son of an African king who cannot access his money but if you send him $10,000. of yours, he would repay you in millions. I know that there are people who actually fall for these schemes. I am happy to not be one of them.

When my stimulus check finally arrived, I found myself momentarily unsettled. How on earth was I going to spend it? Should I use it to help defray my mounting bills? Should I put it all on a credit card? Or could I possibly indulge a portion of it in a new Coach handbag? What to do? What to do?

Thanks to the writings of psychologist Daniel Kahneman, I now know that there is a psychology behind the way we spend money. In October 2002, this Princeton psychologist was awarded the Nobel Memorial Prize in Economic Sciences for his groundbreaking work in applying psychological insights to economic theory, particularly in the areas of judgment and decision-making under the influence of uncertainty.

Kahneman and his deceased research partner, Amos Tversky, PhD, were honored for their pioneering research that countered some of the assumptions of traditional economic theory. They called their alternative theory “prospect theory”.

Prospect theory examines the process of financial decision-making under conditions of risk and uncertainty. The prospect model explains why periodically there are such wide fluctuations in the stock market. It predicted the housing debacle. And it makes sense of why people would drive all the way to a distant Wal-Mart to save a few dollars on a small purchase, but would not do the same for a discount on an expensive Coach handbag.

Traditional economic theory, on the other hand, argues that people make basically rational choices out of self-interest. In other words, we generally spend money wisely but selfishly.

And certainly, when I recently read about accusations of corruption against a certain Alaskan Senator, I thought that traditional economic theory made possible sense of some aspects of his behavior. Some people do indeed use rational decision-making to rob others blind. And they do so for utterly selfish reasons.

But Kahneman and Tversky also discovered that people often fail to analyze situations fully when making complex judgments. Instead, we often make decisions using rules of thumb rather than rational analysis. They found that humans sometimes make decisions based on factors that economists traditionally don't include, such as what is considered to be fair, what happened in the past, and how to avoid losing what we have worked so hard to gain.

In other words, a corrupt Senator may steal because he might consider it unfair that others had stolen in the past and got away with it so why shouldn’t he be entitled to the same? And, having stolen, he may feel compelled to find creative ways to hide ill-gotten gains. Or remain in denial that what he did can be categorized as stealing. Or find ways to justify holding on to “gifts” from his constituents.

Because my stimulus check was honestly earned, I experienced no moral quandary whatsoever over how to spend it. My conflict was far more traditional – should I use it to pay bills or should I stimulate the economy by being utterly selfish? The situation seemed so either-or that I could perceive little risk. In the end, I strove for a compromise. I went to T J Maxx and indulged to the tune of $100. A chunk of the remaining $500. went towards paying bills.

But back to Kahneman and Tversky whose theory also helps to explain the amazing generosity of everyday Americans, and our willingness to sacrifice for others. In one study, these researchers asked people to choose between two hypothetical procedures to cure a disease. Most respondents selected the procedure that saved 80 percent of lives over the one that killed 20 percent -- regardless of the cost. In other words, most respondents chose the altruistic option over the money-saving one.

Traditional economic theory does not explain such altruism. Nor does it explain why a portion of my stimulus check went towards paying for a friend to play tennis at my club several weeks in a row. I have never told her that there is a visitor’s fee – I simply paid it. I’d like to believe that I am just generous that way.

UPDATE: Link to a recent interview with Dr. Kahneman

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