The Negative Wealth Effect Revisited

David Krueger MD

I was talking with the owner of one of our favorite antique stores in an area close to our weekend ranch. He said, “People are just not spending money.” The downtown area of the little town was somewhat dead, and the nursery we frequently visit had few customers.

He continued, “They don’t seem to be out of jobs, no one is making any less money, but people just aren’t spending.” 

This was just before the Coronavirus economic setbacks.  Since I believe homespun research can, at times, approximate results from the neuroeconomics lab, I asked why he felt this was the case. 

“Everybody is watching the news too much.”

The positive wealth effect occurs when rising values of homes, stock portfolios, and retirement accounts make people feel wealthy. Even though no one takes a single dollar from these assets, the heightened mood leads to a sense of wellbeing and more spending. 

People feel the impact of an economic downturn in an inverse way: the negative wealth effect. Even though they make the same money at their same job, people spend less.

We spend, not according to how much money we have, or even what we need, but according to how we feel.  A University of Toronto study demonstrated that when people are in a positive mood, their visual cortex takes in more information. In a positive mood people both see and process a greater number of possibilities in their environment. A good mood enhances the size of the window of our perspective. 

At a time of widespread and unprecedented concern such as we currently have, the emotional contagion (“collective tilt” or herd mentality) of the economic setbacks increases tension and narrows perspective. Neuroeconomists have demonstrated that people who are fearful cling to what they have. Our nervous system shuts down in an adaptive effort at survival.  Uncertainty or anxiety will rigidify principles into rules. At a time of crisis, fear, or uncertainty, people reduce spending. When fear is dominant, money is not only constricted, but hoarded. At such times consumers become risk-averse and hunker down. This has been called the negative wealth effect. 

Additionally, we experience a cognitive bias called availability heuristic, a mental shortcut that overweights the most recent and most charged information and events as a basis of evaluation and decision.  Currently the news, warnings, and statistics hyperfocus on the impact of the virus worldwide – as it should in such a crisis pandemic.  But it can carry over to panic decisions, including selling investments and other emotion-driven reactions.  With the US stock market down 27% in 15 trading days, perspective and balance become essential.

A Buddhist teaching offers guidance for times like these to focus on what we can determine: “Return to the earth now if your mind is troubled and your heart is uncertain, for it is by returning to the beginning that we can clearly see the path.”

Portions excerpted from YOUR NEW MONEY STORY: The Beliefs, Behaviors, and Brain Science to Rewire for Wealth by David Krueger MD  (Rowman & Littlefield, NewYork / London, 2019)  https://amzn.to/2IDsIp7