Inflation "felt" to be not so bad as a wage-cut
Economists and brain researchers in Bonn have discovered a neuronal cause of the so-called "money illusion"
What would you prefer: a three per cent wage rise at five per cent
inflation? Or a two per cent wage-cut with stable prices? Many people, faced
with this choice, would take the first option, although the true purchasing
power of their income sinks in both cases by exactly the same amount, namely two
per cent. Researchers at Bonn University and thhe California Institute of
Technology have now discovered the cerebro-physiological cause underlying this
so-called "money illusion". This effect is of great practical relevance in
that it explains, for instance, why financial policy and inflation can have a
beneficial effect on employment and economic growth.
Many
people view a rise in their income as a good thing, even when the increase is
completely negated again by inflation. This effect is called the "money
illusion", and many economists are of the opinion that it should not exist.
After all, the true purchasing power of the income remains exactly the same. So,
for a rational market activist it should be of absolutely no concern under these
conditions whether his nominal income sinks or rises. However, laboratory
experiments and field studies have repeatedly confirmed that this effect does
indeed exist.
Professor Dr. Armin Falk and Dr. Bernd Weber of Bonn
University have now approached this topic of the money illusion from a
completely different angle. Falk is an economist and Weber a brain researcher -
an unusual alliance. Both have been trying to discover which neuronal processes
underlie economic decisions. For this purpose, they arranged for their test
subjects to "play" economic situations while, at the same time, they monitored
their brain processes.
Experiments in the Brain Scanner
A total of 24 subjects participated in the study which has just been
published. Whilst recumbent in a scanner, they were called upon to solve simple
problems. Success brought a financial reward. At the same time, as the
experiment evolved, the fluctuations in the blood oxygen saturation of diverse
areas of their brains were monitored. This reading indicates the degree of
activity in the relevant area of the brain. The prize-money was not subsequently
paid out in cash, but the successful test subjects were allowed to choose goods
from a catalogue - including CDs, sun cream or computer accessories.
"We had now confronted our test subjects with two different situations",
Falk explains. "In the first, they could only earn a relatively small amount of
money, but the items in the catalogue were also comparatively cheap. In the
second scenario, the wage was 50 per cent higher, but now all the items were 50
per cent more expensive. Thus, in both scenarios the participants could afford
exactly the same goods with the money they had earned - the true purchasing
power had remained exactly the same." The test subjects were perfectly aware of
this, too - not only did they know both catalogues, but they had been explicitly
informed at the start that the true value of the money they earned would always
remain the same.
Despite this, an astonishing manifestation emerged: "In
the low-wage scenario there was one particular area of the brain which was
always significantly less active than in the high-wage scenario", declares Bernd
Weber, focusing on the main result. "In this case, it was the so-called
ventro-medial prefrontal cortex - the area which produces the sense of quasi
elation associated with pleasurable experiences". Hence, on the one hand, the
study confirmed that this money illusion really exists, and on the other, it
revealed the cerebro-physiological processes involved.
An
Explanation for the unpopular "Teuro"?
The results achieved by
these scientists in Bonn demonstrate that as far as the brain is concerned money
is represented as being "nominal", and not only "real". In other words: people
like to be seduced by large numbers. This is of great practical relevance as the
money illusion explains, for example, why the economy allows itself to be
reflated by expansive financial policy. It also offers an explanation for why
nominal wages rarely sink, whereas true wages, in contrast, fall in value in
periods of inflation. Many economists also see the money illusion as an
explanation for speculative bubbles, such as those in the property or shares
markets. Armin Falk declares: "Even minor departures from rational behaviour,
i.e. a "little money illusion" can have major economic consequences".
Bernd Weber, Antonio Rangel, Matthias Wibral, Armin Falk: The medial
prefrontal cortex exhibits money illusion; PNAS 2009
Contact:
Professor Dr. Armin Falk
Institut für
Gesellschafts- und Wirtschaftswissenschaften, Universität Bonn
Telephone:
0228/73-9240
E-mail: [Email protection active, please enable JavaScript.]
Privatdozent Dr. Bernd Weber
Life&Brain-Center,
Universität Bonn
Telefon: 0228/6885-262
E-Mail: [Email protection active, please enable JavaScript.]
