Podcast

Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

Thursday, January 6, 2011, 12:03 AM

Looking back at the carnage created by the bursting of the credit bubble, it’s natural to scratch your head and ask “How did we ever let that happen?” Behavioral economics exists to answer questions like this.

Last week Chris sat down with Dan Ariely, gallivanting behavioral-economics-researcher-extraordinaire, who is breathing new life into this previously obscure field of study. The resulting interview is full of fresh, non-intuitive insights and shines light on how the human brain is often hard-wired for irrational action when it comes to money.

One of the key takeaways for us was how Dan’s research provides an empirical explanation for why inflation will likely win the day: our mental programming leads us to prefer behavior that favors it.

Dan has a fresh and pretty non-traditional way of explaining the more intriguing aspects of human behavior, including:

  • The overwhelming influence of emotion in driving our decision-making
  • Our vulnerability to present temptations & our overestimation of our future virtuousness
  • Our amazing capacity to justify irrational circumstances
  • Our blindness to conflicts of interest when they work in our favor
  • Why we do a poor job of appreciating future risk

Each of these played a role in the excessive behavior responsible for the credit crisis – and continue to hamper our ability to handle its aftermath rationally today.

Our time with Dan was fun and fascinating. If you’re not acquainted with it already, the perspective offered by behavioral economics is a valuable addition to add to your world view. We’re definitely planning to look through its lens more often going forward.

Click the play button below to listen to Chris’ interview with Dan Ariely:

About the guest

Dan Ariely

Dan is the James B. Duke Professor of Psychology & Behavioral Economics at Duke University, where he holds appointments at the Fuqua School of Business, the Center for Cognitive Neuroscience, the School of Medicine, and the Department of Economics. He is also a founding member of the Center for Advanced Hindsight.

Using simple experiments, Dan studies how people actually act in the marketplace, as opposed to how they should or would perform if they were completely rational. His interests span a wide range of daily behaviors and his experiments are consistently interesting, amusing, and informative, demonstrating profound ideas that fly in the face of common wisdom.

He is the author of the New York Times Bestseller Predictably Irrational: The Hidden Forces that Shape Our Decisions and The Upside of Irrationality: The Unexpected Ways We Defy Logic at Work and at Home. His research has been published in leading psychology, economics, and business journals, and is featured occasionally in the popular press.

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15 Comments

plato1965's picture
plato1965
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

I liked the application of  time preference affecting the inflation/deflation tradeoff ...   interesting!

I can see the "identifiable victim" effect as also biasing in favour of  inflation/bailouts/subsidies at the expense of the anonymous taxpayer...

I guess it's a variation on the "broken window" fallacy too, wherever benefits are visible, immediate and personal we favour them even if the associated costs are far larger but anonymous, delayed, and dispersed.

It's easy to see how the same principles apply to pollution (concentrated benefits, widespread costs), tragedy of the commons, resource scarcity..  and a "non-negotiable" lifestyle...

It's a sort of perverse, myopic utilitarianism... the greatest temporary good, as soon as possible,  for the most visible.

JAG's picture
JAG
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Great Interview!

Wow! What a fantastic dose of content, delivered in a most effective manner (for us auditory learners, at least). That podcast was full of a lot of interesting ideas and observations.

I would have to say that the "high price of ownership" concept applies equally well to gold ownership (and its associated blindspots) as it does to the house ownership example discussed. It wasn't until I sold my physical gold that I recognized some of the theoretical and emotional baggage that comes with the "gold identity".

Applying the deferred-pain observation to the inflation/deflation debate was a bit of a stretch in my opinion. Of course people are inclined to defer pain, but they never escape the consequences of that pain by doing so. I deal with people in physical pain everyday in my practice, and I cannot cite one instance where deferring the pain (with painkillers, for instance) allowed anyone to ignore the underlying problem in the long run. Eventually the painkillers no longer work, and the person is left with dealing with a more complicated problem than they originally sought to avoid in the first place.

Inflating the credit supply (QE) is just a painkiller for the excessive debt pathology plaguing our economy. Sooner or later, QE will no longer work to ameliorate the symptoms and underlying pathology will have to be dealt with directly. Debt-deflation is not a choice, but a consequence. 

Thanks again for the interview, I look forward to more.....Jeff

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crazy horse
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

The thought of behavioural economics theory in the hands of government economists is frightening.

I agree with Chris that the moral hazard element was and is an important factor in how banks have behaved. This is supported by comments from bank insiders including Nassim Taleb. That Dan Ariely - an influential economic researcher - doesn't get this and that he doesn't understand the fraudulent nature of a government backed fractional reserve banking system I found disturbing.

Thanks for presenting the podcast.

cmartenson's picture
cmartenson
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

I thought that the deferred pain insight was the most important of a very revealing set of insights.

Across the centuries and across cultures, living under entirely different sets of circumstances we find people generally behaving the same.  The question as to why that might be is rooted in biology and how we are wired up.  Without imposing our values on whether that's the way we aught to be, or should be, or not, I find the observation that people will strongly favor deferring an immediate and certain pain for a distant and uncertain pain to be highly useful and telling.

Also, the idea that simply putting some complexity between the action and the consequence, as little as a single step,  provides sufficient 'allowance' for individuals to rationalize otherwise unacceptable behavior(s) is powerful.

I feel like three's some sort of basic truths being uncovered by this work; ones that explain much and are like little light bulbs going off in my brain.  

Of course, my main background, once upon a time, is rooted in the biological sciences (Pathology and Cell Biology) and I view humans as organisms wired up and programmed just like any other.  Understanding that base programming is essential to getting a good outcome.  Never expect a basset hound to herd sheep, and never expect a sheep dog to lie quietly in your house all day without destroying it.  That sort of thing.

If deflation represents an immediate pain, and it does, and inflation represents an uncertain future offering the chance that somehow we might dodge the bullet entirely (hey, there's always a chance, right?) then B.E. explains why that path is a slam-dunk choice for policy makers no matter that the risks associated with inflation might be an order of magnitude larger than deflation.

People are rationalizers, not rational.

Vanityfox451's picture
Vanityfox451
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

Chris,

Utterly fascinating man. I'm forever drawn to creative people, especially those who lean toward observational study, who identify deeply with a personal experience, sometimes a devastating one, with the result that they become hard-wired advantageously from the event, turning inward upon themselves and finding a substance that can change others lives about them.

Sir Ken Robinson suffered from polio in his childhood, and his inner strength from his life changing experience gained him an ability of empathy that far surpasses ordinary routine observation : -

Dan Ariely suffered seventy percent burns due to an accident with a magnesium flair explosion when only eighteen. He far surpasses many of the observational skills, well beyond most I feel, because of this experience. Both gained standing ovation, and deservedly so, at recent Ted Talks conferences : -

There is such a genuine embrace to understand and to make this world a better place to live, and his energy and dynamism is fully infectious and engaging. So much so that I've surfed all over the net to find him today. An interview that expands further with your discussion left me with the conclusion that I wanted to know much much more about his work : -

I've read the opening previews of his books at Amazon.com that you linked above, leading me to buy: -

Predictably Irrational: The Hidden Forces That Shape Our Decisions

Wikipedia Review wrote:

{Link...}

Predictably Irrational: The Hidden Forces That Shape Our Decisions is a 2008 book by Dan Ariely, in which he challenges readers' assumptions about making decisions based on rational thought. Ariely explains, "My goal, by the end of this book, is to help you fundamentally rethink what makes you and the people around you tick. I hope to lead you there by presenting a wide range of scientific experiments, findings, and anecdotes that are in many cases quite amusing. Once you see how systematic certain mistakes are--how we repeat them again and again--I think you will begin to learn how to avoid some of them".

Thank you sincerely for sharing the pleasure he gave you with this interview.

~ VF ~

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James Wandler
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

All,

Are you tired of being a sheeple?  Have a look below and you'll see what I mean.

An item of signficant value to me was Dan's comment (paraphrasing):

"You can motivate people through negative emotions but then you must tell them what to do."

Look carefully at the sentence and you'll see how easy it is for all of us to be controlled through negative emotions (mainstream media, advertising, entertainment of all sorts, etc.) where a logical conclusion (or hidden message) is drawn to pull the strings of our actions. 

What's more Dan voiced concern about how easily sensitized our emotions can be to particular events (the example of the dog on the sinking ship or the slaughtering of a calf) - I believe his inference was that this can be used to misdirect us from other issues (keep us off the ball).

There is only one person who has control over you in this world - and that is yourself - IF you want to take back that control.  So if you don't want to be a sheeple anymore the way to do this is to get control over your emotions.

Impossible you say?  So would I have thought until I took a course a couple months ago called ZPoint.  You can find more out about it at www.zpointforpeace.com   I now use the Bedtime Therapy on a daily basis to clear my negative emotions from the day and get a better sleep. 

Anyways, 2011 is going to get a lot more crazy and I think we will only have a short time until the next big financial crisis in April.  When you are ready to give up the half box of chocolates and do the work necessary to get the full box of chocolates then keep this website I recommended in mind.  After all, Dan mentions that pain is the other motivator - how much pain are you willing to keep taking?

All the best,

James

P.S.  As a friendly challenge...if anyone doesn't like my idea I hope they can respond without negative emotion...although I guess later they can enjoy the irony...

guardia's picture
guardia
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

crazy horse wrote:

I agree with Chris that the moral hazard element was and is an important factor in how banks have behaved. This is supported by comments from bank insiders including Nassim Taleb. That Dan Ariely - an influential economic researcher - doesn't get this and that he doesn't understand the fraudulent nature of a government backed fractional reserve banking system I found disturbing.

The way I understand it, he's talking in generalities and about herd behavior... The majority of humanity is not evil. There are sociopaths out there, but they need to figure out how to manipulate the "sheeples", otherwise nothing happens. They would get killed, and game over.

Samuel

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msnrochny
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

Great and instinctively sound insights.  This article in the NY Times jives with it all.  Someone from MIT has actually proposed a wallet linked by Bluetooth to your bank account that is more difficult to open (uses a computer controlled hinge designed into the it) depending on the amount of your account balance - i.e., a technology means of interrupting the human tendency for immediate gratification.  Fascinating stuff.

http://www.nytimes.com/2011/01/02/weekinreview/02siegelbernard.html?src=un&feedurl=http%3A%2F%2Fjson8.nytimes.com%2Fpages%2Fweekinreview%2Findex.jsonp

JAG's picture
JAG
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

Vanityfox451 wrote:

There is such a genuine embrace to understand and to make this world a better place to live, and his energy and dynamism is fully infectious and engaging. So much so that I've surfed all over the net to find him today. 

VF,

I share your expressed sentiments and I very much enjoyed the additional material that you provided. 

Thank You,

Jeff

grondeau's picture
grondeau
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

Nice interview.  Indeed we seem to be wired to discount the future.  In fact, I would argue that this fact is behind the reason that the Fed picks a non-zero inflation target for their monetary policy.  Their job is to find that "sweet spot" where the pain of inflation's effect on fixed assets (like pension funds and 401k money sitting around) is  about the same as our "discount rate" for the future - and hence is a spur to investment.  

Hyperinflation,however, is a different beast.  It has its own immediate pain.  Hence, the Fed and the federal government has very reason to avoid this path, even though it may cure "deficit" problems.  Mild inflation, on the other hand, is both stimulative and provides a nice tax that I'm sure Dan Ariely would agree is easier for us to tolerate than actually having to pay money today in real taxes.  Similarly, wages never go down in a slump because there is a great deal of emotional investment in that meter of our worth that we are unwilling to give up.  So there is much-much to keep inflation rolling along.  I would disagree that there is any reason to expect Hyperinflation, however.  The FED can always create a slump by raising interest rates high enough to shut off the investment machine.  It's hard to see how inflation can maintain traction under those conditions.

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Mikey1052
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

I thought this letter would be good to share but could not decide where to place it. I decided that this would be as good a place as any as it deals with our hardwired nature to inflate etc...

An open letter to Harry Reid from Addison Wiggins

January 7, 2011

The Honorable Harry Reid
Majority Leader
United States Senate
Washington, DC 20510

Dear Mr. Leader,

I'm writing in response to Treasury Secretary Timothy Geithner's appeal to you to raise the debt ceiling.

I understand that you didn't ask for my opinion. And with no political positions on my curriculum vitae, you may not even recognize my name. But I have co-authored two books warning about the United States' fiscal situation, starting with Financial Reckoning Day in 2003 and followed by Empire of Debt in 2005. I mailed copies of the latter to you and the other members of Congress free of charge. While it may not be sitting on your nightstand, I trust that you're at least aware of the book.

After we published the book, I wrote and produced a documentary, I.O.U.S.A., which was screened in competition at the Sundance Film Festival, nominated for a Critics Choice award and shortlisted for an Academy Award. The film attempts to present the fiscal crisis facing the United States in a way that the average American could understand. The film took two years to produce and premiered on Aug. 22, 2008 - almost a month before Lehman Bros. declared bankruptcy, kicking off the Panic of '08.

So after a decade of attempting to bring the root causes of our economic woes to light, I humbly suggest that the shortsighted tone of Mr. Geithner's appeal is itself part of the problem. It is, in fact, no different than Secretary of Treasury Hank Paulson's frantic three-page proposal that kicked off the bailouts in September 2008.

Sir, in short, by raising the debt ceiling, we're delaying the day of reckoning yet again. Instead of paying for our excessive spending today, we'll pass that burden on to our children and grandchildren. I have three young children. And I, like many Americans, already find it a challenge to educate them and provide for their health care. Now I must also worry about what their future is going to look like...what opportunities will they find when it's their turn to join the work force or start businesses?

Mr. Geithner shares his fears of a default in his letter to you. But his request simply means my children - everyone's children - will have to deal with that default on their own.

Do we really want our children burdened by higher taxes, excessive government regulation, higher mortgage rates, reduced incentives to start their own businesses and, as things are going, the end of the freedoms that you, Mr. Geithner, the rest of the American public and I cherish?

Freedom is the very promise that America bestows on history. But now, through our own malfeasance, we are in a position of telling the world, "We cannot afford to offer you the opportunity to enjoy that freedom anymore."

How did it come to this? And why perpetuate the very malfeasance that threatens our future prosperity?

For most of America, understanding the fiscal condition of the nation is no easy task. For that, they place their trust in you. No doubt, it's easier to do exactly what our Treasury secretary is asking you to do - ignore the problem and continue to kick the can down the road. But I'm asking you, on behalf of future generations, to think deeper about the problem and begin addressing it today.

To help you with your decision, here are some images you can use to illustrate the magnitude of the national burden.

As Mr. Geithner stated in his letter to you, "In February of 2010, Congress passed legislation to increase the debt limit to $14.29 trillion." To grasp that staggering figure, imagine stacking $100 bills on top of one another. To reach $14.29 trillion, your stack would soar 9,721 miles into the sky!

Said a different way, that's like 1,767 mountains of $100 bills the size of Mount Everest piled on top of each other.

Of course, the current debt wouldn't be a problem if tax revenue were exceeding our spending and therefore reducing the debt. But we both know that is not happening. Even if we taxed all Americans 100% of their income for an entire year, we still wouldn't be able to pay off our $14.29 trillion hole

What's more, the interest we're paying on the current debt is forcing us deeper and deeper into the hole. According to the TreasuryDirect.gov website, the interest payment on our debt was a massive $1.13 billion per day - for a total of $413 billion - in 2010.

The interest payment alone amounts to record-breaking deficits hit during the Bush administration just a few short years ago. If you agree to raise the ceiling, you effectively agree to drive up the interest payments until they exceed tax revenue - creating a situation in which we'll be forced to default, eventually. And the longer it takes to happen, the worse it will be for our children.

The Treasury secretary outlines how catastrophic a default would be for the financial system and the integrity of the United States:

Default would effectively impose a significant and long-lasting tax on all Americans and all American businesses and could lead to the loss of millions of American jobs.

When, I ask you, do we begin addressing the root problem? When do we admit that we're spending beyond our means and begin to address the problem in earnest? "We can live beyond our means for a very long time," to paraphrase a leading financier from I.O.U.S.A., "and we can do it on a very large scale - but we cannot do it forever."

The United States is like a private company suffering from a pension burden it did not plan for and that is losing market share because its products are no longer competitive. And it is as if the management has decided to take an extended vacation, rather than hold a meeting to find a way out of the hole.

In Congress, you don't address the real problems. You talk around them, play politics with them and then make frantic appeals at the 11th hour to borrow more money to paper over the problems again for yet another year.

At this pace, how do you honestly believe the government will ever balance its books again? In the era of uncertainty created by mayhem in Washington and ever-increasing global competition, how do you expect the economy to get back on track?

Let's put the numbers aside for a second. I'd like to ask you a simple question:

Imagine for a moment that you've chosen to smoke cigarettes all your life. You've ignored the warnings about them that appear all around you. Then, eventually, and unfortunately, you get diagnosed with lung cancer.

Luckily, you've caught the disease in its very early stages. The doctor presents you with two choices.

First, you can enter chemotherapy. The road to recovery, the doctor tells you, will be harsh. You'll suffer extreme nausea. You'll hardly be able to swallow from the ulcers you develop in your mouth. In short, you'll go through hell in an attempt to beat the disease. But because you caught the disease after the first symptoms appeared, you have a high chance at a full recovery.

The doctor also offers a second alternative. He's worked out a deal that allows you to rid yourself of the disease instantly. No pain. No suffering. No hell. All you have to do is agree to give the disease to your 2-year-old grandson.

Would you make that deal, Mr. Leader?

I trust you'll make the right decision about our nation's fiscal health. At the very least, there needs to be an honest debate over raising the debt ceiling. If you provide the rubber stamp Mr. Geithner is asking for, you will be as guilty as he of passing the buck. Each time the buck gets passed, the stakes get higher. The default Mr. Geithner fears only looms more ominous in our future.

The newly elected speaker of the House, John Boehner, has gone on record saying he'll agree to increase the debt limit because we have to be "adults" about addressing the fiscal crisis the nation faces.

What, may I ask, is "adult" about failing to address this issue altogether?

Sincerely,

Addison Wiggin
Executive publisher, Agora Financial
Co-author, Financial Reckoning Day and Empire of Debt
Executive producer, writer, I.O.U.S.A.

cc: The Honorable John A. Boehner, Speaker of the House
The Honorable Nancy Pelosi, House Minority Leader
The Honorable Mitch McConnell, Senate Minority Leader
The Honorable Dave Camp, Chairman, House Committee on Ways and Means
The Honorable Sander M. Levin, Ranking Member, House Committee on Ways and Means
The Honorable Max Baucus, Chairman, Senate Committee on Finance
The Honorable Orrin Hatch, Ranking Member, Senate Committee on Finance
All Other Members of the 112th Congress

Marco_Lugon's picture
Marco_Lugon
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

I think Dan gets his math wrong.  He gives an example where if given a choice of whether you want half of something today or all of something in a week, most people want it today ... yet if you time shift and ask people if they want half of something in a year, or all of something in a year and a week .. most people are willing to wait.  Then adds, it's the same week.

Not quite.

The truth is you're asking if someone is willing to wait 2% longer (372 days versus 365 days from today) for 50% more ... versus (let's assume you compare 1 vs. 7 days), 600% longer for 50% more.  Seems completely logical to me that you'd choose to wait in the future, but take 50% today!

Alas, you're not comparing a week to a week, you're comparing a week to year and a week ... very different.  If you've already waited (and 'risked') 98% of the time, why not risk another 2% for another 50% payout.

maveri's picture
maveri
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

I found another talk that Dan gave that sort of dovetails into this one.

In regards to cheating, Dan points out that people's fudge factor changes depending on the group we associate with in terms of evaluation.

It's interesting because it shows why collective groups of people will often come up with a decision that may push further than the individuals in that group would otherwise accept. It's the group and the association that people in the group have that skews the decisions - anyone who's watched the documentary 'The Corporation' will understand.

While Dan didn't mention it, the spin-off about the assoicative group alters our perception and our fudge factor when it comes to cheating etc reveals to me why self-regulation in an industry (or an individual for that matter) will never work long term - the rules of what's right and wrong tend to creep

EDIT: lol - I didn't see vanityfoxes post which contains a link to this youtube video.

guardia's picture
guardia
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Re: Dan Ariely Decodes Why Humans Are Hard-Wired To Inflate

maveri wrote:

While Dan didn't mention it, the spin-off about the assoicative group alters our perception and our fudge factor when it comes to cheating etc reveals to me why self-regulation in an industry (or an individual for that matter) will never work long term - the rules of what's right and wrong tend to creep

Another form of the "shifting baseline". Interesting, thanks for pointing this out!

Samuel

guardia's picture
guardia
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Separate but unequal: Charts show growing rich-poor gap

More from Dan's research here!

Separate but unequal: Charts show growing rich-poor gap

Samuel

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