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.