The Frontal Cortex


Tyler Cowen weighs in on the latest twist in the bailout plan, which involves funneling money to credit card companies. Tyler asks if the Feds should really be in the business of encouraging more credit card borrowing. (I’ve actually been enjoying getting fewer credit card offers in the mail.) His answer:

No, and especially not with federal dollars. We’re talking about credit card debt as a means of financing consumption expenditures. I am not sure what is the going credit card interest rate for the marginal borrowers who will be aided by this new change in the Paulson plan, but I believe it is over fifteen percent.

More spending today, in return for less spending in the future. At a rate of, say, fifteen percent. Or higher. Think of our government as “borrowing” aggregate demand at a rate of fifteen percent or higher. Of course our government can, on its own, borrow at a much lower rate of interest than that and then stimulate aggregate demand on its own, through state and local governments, or with a tax cut. Maybe our government is afraid of damaging its credit rating but is it really a good solution to have its poorer citizens do the borrowing on their credit cards instead?

I’ve blogged about this before, but it’s a reminder: one of the reasons credit cards are such a popular form of debt is that they take advantage of some innate flaws in the brain. When we buy something with cash, the purchase involves an actual loss – our wallet is literally lighter. Credit cards, however, make the transaction abstract, so that we don’t really feel the downside of spending money. Brain imaging experiments suggest that paying with credit cards actually reduces activity in the insula, a brain region associated with negative feelings. As George Loewenstein, a neuroeconomist at Carnegie-Mellon says, “The nature of credit cards ensures that your brain is anaesthetized against the pain of payment.” Spending money doesn’t feel bad, so you spend more money.

Perhaps the real goal of the Paulson plan is precisely that: encourage people to use credit cards as a way to jump start retail spending. Because we’ve got a shiny new Visa card, we’ll be less sensitive to the fact that our 401(k) is down 40 percent, the value of our home is down 20 percent and the unemployment rate shows no sign of stabilizing anytime soon. Call me crazy, but ludicrously expensive debt (rates of 25 percent or more aren’t uncommon on credit cards) hardly sounds like a sound long-term solution.


  1. #1 CRM-114
    November 13, 2008

    Why don’t we bail out the credit card companies on revolving charges with 29% interest?

    Oh, right, they’d go broke.

  2. #2 OftenWrongTed
    November 13, 2008

    Descartes’ Error?

    “A man is incapable of comprehending any argument that interferes with his revenue”
    Rene Descartes

  3. #3 Luci
    November 14, 2008

    The truth is, when we say of a gentleman that he lives elegantly on nothing a year, we use the word ‘nothing’ to signify something unknown; meaning, simply, that we don’t know how the gentleman in question defrays the expenses of his establishment.

    Thackeray said it. Vanity Fair has credit crises covered, with dire consequences for most of his poor puppets. How many Becky Sharps are out there these days?

  4. #4 Donna B.
    November 16, 2008

    How does this relate to the use of “check” cards, ie debit cards that are processed just like credit cards? Do I spend more than I would if I had to write a check or hand over cash when I use my “check” card?

  5. #5 Peter
    November 16, 2008

    Johah, it seems to me you post about credit card spending about once a month. Is it by any chance connected to the arrival of your bill? I appreciate the regular reminder not to use my card unwisely ^_^

  6. #6 Dave
    November 16, 2008

    Get your tax dollar’s worth by charging everything you’ve ever wanted to buy on a credit card, then let it charge off. Don’t even make one payment. Responsable-types get nothing but the bill. Join the fast and loose crowd and let Nancy Pelosi and Paulson pay the bill.

  7. #7 Amrapali
    November 17, 2008

    Jonah this absolutely interesting information. I never thought, that using a credit card to make payments is easy as one doesn’t feel the pinch of spending and incurring debt immediately. More reason for all to be watchful on how much credit card debt we are incurring and take some preventive measures to control spending and mange debts.

  8. #8 tinisoli
    November 17, 2008

    In a similar vein, I wonder if there is evidence that getting handed a wad of cash at the end of a hard day’s work is more emotionally rewarding than receiving a direct deposit into your checking account 2-5 times per month, or if, in fact, it makes one work harder, too. I still remember how sweet it felt to get an under-the-table envelope full of twenties, tens, and fives after a week or weekend of work. Nowadays I just see the deposit in my bank account, but it feels so intangible and meaningless.

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