The following op-ed will appear in a print edition of The Crimson the week of June 2.

The United States government is clearly under some pressure to take some actions in an attempt to stabilize the economy, and as a consequence, recently announced a $153 billion (more or less) stimulus package that is supposed to rejuvenate the economy and stabilize the market (H.R. 5140— the Economic Stimulus Act of 2008).

Is sending all taxpayers a tax rebate going to get us to do what the government wants us to do and spend more? Is the current plan optimally designed to achieve the government’s goals? Is sending people a tax rebate the best way to fuel the economy?

The field of behavioral economics (in particular two amazing researchers: George Loewenstein, and Drazen Prelec) has rather convincingly shown that money given in different forms can have fundamentally different effects. For example, imagine that you have just finished a delicious dinner for two and it is time to pay the $100 bill. You open your wallet and are faced with your options: cash or credit? The reality is that no matter which option you choose, you will pay the same amount. But paying with a credit card feels very different than paying with cash—it is somewhat less painful.

Why is paying with credit cards less painful? When we pay with cash we consume and pay at the same time, but when we pay with a credit card we are decoupling the timing of consumption from payment. We eat now and pay later, making the pain of paying lower and the enjoyment from the meal higher. We can even push the pain of paying to a more extreme level. Imagine that when you step into the restaurant the waiter tells you that the average diner eats about 50 bites and spends about $50 in this restaurant, making it a dollar per bite. He further informs you that today they have special deal of $0.5 per bite, and that a waiter stands a few feet from your table will watch you and mark every bite you take so that the end of the meal they will only charge you for the number of bites you took. Sounds like a great deal!

Or does it? Whatever financial benefit you might derive from such a deal, the real joy from the dinner will be very low because each bite you take reminds you how much you are spending. This might be a good dieting approach, but not a way to enjoy spending your money. What this idea shows is that the way you pay has important psychological implications on how you view the money you are spending—what we call the “pain of paying”—even though on a rational level, we all know that money is fungible.

How is the pain of paying related to the stimulus packages? If different payment methods have significant effects on the ease with which people will spend their money, shouldn’t the government administer tax rebates in such a way that minimizes the pain of paying?

So which delivery method makes the most sense for distributing tax rebates? Here behavioral economics has been instructive as well. In particular, years of research have demonstrated over and over that our intuitions about the relative effectiveness of different approaches are often wrong. Over the years we’ve learned that we are often wrong about what drives our dishonest behavior, about what makes us enjoy a glass of beer, about what makes us willing to pay different amounts for different products, etc. In essence, our intuitions about what drives our behavior are often misguided.

Given that the method of delivery could make a large difference, and given that our intuitions about their relative effectiveness could be wrong, what should we do?

One answer is to conduct an experiment, as this is the only method we have for testing what really works and what is likely to fail. In the same way that we force drug companies to test the efficacy of their drugs before rolling them onto the market, shouldn’t we ask the government to test their ideas before they invest billions of our tax dollars on some stimulus packages?

Conducting such experiments is by no means simple, but in order to learn what is truly effective, we must select from among a few leading candidates, try them out in different markets or market sectors and compare their effectiveness over time. This sort of experiment is not only useful in helping us determine how to spend the immediate stimulus package but, more importantly, it can help us with market problems that we are certain to encounter in the future.

We all have some complaints about the Food and Drug Administration (FDA), yet we also realize that without the FDA medicine might have been nothing but leeches and placebo–isn’t it time to take the same systematic approach to economic policies that are so central to our society?

Maybe the Fed should hire some experimentalists and start investing in learning about these hugely important decisions.

And if the Fed is not going to experiment with this important decision, my suggestion is to send people a pre-paid debit card with the government’s logo and a statement that reads: “spend the government’s money.”


Dan Ariely is the Alfred P. Sloan Professor of Behavioral Economics at MIT’s Sloan School of Management and the author of the New York Times Best Seller “Predictably Irrational.”