Austerity, & the peak-end rule

There's more wisdom in Simon Wren-Lewis's casual comments than there is in many people's considered thoughts. Discussing the "absurd" idea that the recovery validates fiscal austerity, he says: "Next time you get a cold, celebrate, because you will feel good when it is over!"

Such celebration is a common psychological phenomenon. When I used to get attacks of gout, I would feel euphoric as they faded away because mere discomfort felt wonderful after extreme pain.

However, this euphoria can distort our judgments. Daniel Kahneman has pointed out (pdf) that our memory of painful experiences follows what he calls a "peak-end rule"; we judge them not by the moment-by-moment experience of pain, but by a comparison of the worst pain with the end-point. If we experience severe pain followed by discomfort - as in an attack of gout - our memory of the episode is not as unpleasant as it would be if we experienced ever-increasing levels of pain and then a sudden stop.

This pattern fits in with George Osborne's rising approval ratings. Living standards are still squeezed, but less so than a few months ago. Pain has thus given way to discomfort, which means the peak-end rule makes austerity feel good.

Although this rule describes our retrospective assessment of pain, it is irrational in two ways.

First, one corollary of the rule is duration neglect; our memories of painful episodes aren't well correlated with the length of such episodes.

Secondly, the rule implies that adding discomfort to the end of a period of pain can actually improve our memory of that period - even though the discomfort is unnecessary. As Kahneman wrote: "adding a period of diminishing discomfort to an aversive episode makes it globally less aversive." This means that, in retrospect, we look favourably upon gratuitous discomfort.

Public approval of Osborne isn't based merely upon bad economics, therefore. It's founded in psychological mechanisms which distort judgments. "Bourgeois" social science corroborates the Marxian claim that political beliefs can be subject to false consciousness.

One other thing. Kahneman's theory is based upon a study (pdf) of colonoscopy patients. In this sense, George Osborne is very much like a pain in the arse.

Comments

[Luke]

I'd have thought George Osborne = colonoscopy was worthy of comment. I guess this proves your general point about how little we know.

[joe]

Kahnemnan's work on cognitive biases is being thoroughly exploited by commerce and politics. A badly educated public is being taken for a dangerous ride through their total ignorance of their in-built cognitive biases. It is similar in danger to the rise of eugenics following Darwin.

How many now believe that G Brown caused the World banking crisis? How many even pause to consider that every single UKIP claim is a total lie?

And where is the media in this exposing fakery, false headlines and bogus statistics? Absolutely nowhere except perhaps the Guardian/Observer/Independent.
Nowadays, near all of the public are getting fooled all of the time.

[dilbert dogbert]

Re: colonoscopy

I loved the drugs!!!!

[ChrisA]

I don't know why you keep quoting Wren as some kind of authority on what Osborne did wrong, his ideas about the economy over the last few years have been closely followed by Osborne.

Let me explain;

Wren's model of the economy is that "austerity" reduces growth as it reduces inflation. He wants to generate inflation because this will reduce real wages and so increase employment because unemployment is basically caused by sticky wages. His suggestion is to increase government spending to raise inflationary expectations , which will raise inflation, which will lower real wages, which will increase employment, which will then raise growth expectations, which will finally generate real growth.

So what did Osborne actually do? In the UK government spending has never fallen despite all the rhetoric, the deficit continued to rise. In 2011 the UK had a deficit of 8.8%, the third highest in the world, after Egypt and Greece. Net debt in the UK is now over 150% of GDP compared to 70% in 2007. There was no austerity. So what have we seen, actually pretty good employment growth, but real wages falling (generating the silly headlines about how wages were not keeping up with inflation, that's the whole point). And now we are seeing real growth occurring, actually quite strongly. So Osborne has actually been following the Wren playbook quite closely. So why is Wren so dismissive of what occurred? It seems like Wren feels more could have been done that actually was done. But surely Osborne could not have borrowed even more? Think of the hangover of debt that would leave the UK in. We now owe more than 150% of our GDP repayment of which will be a huge drag on the economy for many years to come. Could there not be a better way?

Indeed, contra Wren and Osborne, there is a better solution, a better way to generate inflation. Instead of borrowing money, the Government simply prints it. In this case we still get the beneficial effects of lower real wages. But we don't have the massive debt hangover. This approach is in all the text books as superior to fiscal policy proscriptions for this and other reasons. The reality is that the BoE manages inflation, fiscal efforts to raise inflation are simply offset by the BoE if the inflation is above whatever the target set for the BoE. So if the BoE can control inflation, why not do it directly? Both Wren and his disciple Osborne got it wrong and we will be paying the price for many years to come. The proper approach should have been a massive phased reduction in public spending (to get rid of the Brown excess), coupled with a the BoE being given an NGDP target to maintain nominal growth of 5% per year, through printing of money.