Do Credit Cards Encourage Deficit Spending?

Have you ever ended the month with a larger credit card balance than you expected? If you’ve ever had substantial credit card debt, in retrospect, would you ever have taken out a loan up-front to make those same purchases?

The painless experience of paying by credit card, and the uncertainty of how much your bill will actually be at the end of the month lead to an almost natural abuse of credit cards argues George Loewenstein, neuroeconomist at Carengie Mellon.

Remember, neuroeconomists are those morphing neurologists working to determine how our emotions and natural cognitive biases affect decisions that pure economic theory predicts will be totally rational. (And if you think spending is rational, I encourage you to go shoe-shopping with my friend Melody. You will end the adventure entirely disabused of rational markets theory.)

When you use a credit card, Loewenstein notes, it just doesn’t generate that same feeling of giving something up. This is supported by a marketing professor’s study at the University of Toronto (Dilip Soman) indicating people far more often tend to underestimate, or even fail to recall, how much they’ve spent when they pay by credit card versus cash. Worse yet, this lack of spending conciousness tends to lead us to slide passively into debt Loewenstein argues, rather than by explicit decision that the purchase is worth taking on the debt and paying the item’s total interest-inflated cost.   

When I compare this to my own tendencies, it rings true. For example, if I take out my budgeted allowance for groceries in cash, the very act of watching that pile of cash dwindle and carefully adding up purchases in my head to make sure they don’t exceed the cash in my pocketbook, makes it much easier to say no to things we might like, but don’t need.

Which also makes me wonder, if I were a merchant, could I increase sales by providing stronger suggestion or incentive to pay by credit card? Now there is a study for testing in a down market.