The St Louis Fed Explains Why Americans Have Such An Addiction To Debt

Photo: Associated Press

When we buy another pair of Manolos or play just one more game of solitaire before starting that project, we are living in the moment and risking a lifetime of debt.Economists have a term for this foolish thinking, which is discussed in a newsletter from the St. Louis Fed. “Time inconsistency” is the tendency for instant gratification to overpower the potential for future regret.

Unfortunately this phenomenon has led to a debt crisis both for American consumers and the governments.

Fed research analyst E. Katarina Vermann says the way around this is to create a mandatory spending plan, whether at the mall or in Congress. This could be as simple as the making a grocery list and not deviating from it at the store:

So how can individuals and governments maximise lifetime utility in the face of time inconsistency? Rather than making decisions with discretion—that is, selecting a course of action once a situation occurs— economists propose enacting credible rules—that is, mandating a predefined action/plan for a given situation. For our shopping example, a cash-only rule or a credit card with a lower spending limit may have prevented a splurge. In the case of the debt ceiling, a balanced-budget rule (as many state governments have) may have prevented the debt ceiling crisis. Using credible rules (e.g., enforcing a strict personal spending limit or a federal debt ceiling that cannot be raised) forces people to commit to certain actions. As a result, they will act in a more time-consistent manner: Their decisions today will take into account their future happiness.

Now see 15 ways supermarkets trick you into spending more money >

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