Psychologists and behavioural economists call it “mental accounting”. People have a tendency to put their money in little mental “pots”. So, for instance, there’s the money set aside for the weekly groceries, the money to pay for the summer holiday, the money from Grandma which she said should be spent on school books, and so on.
But what’s curious to economists is that people will often nurture these little pots while having expensive debts at the same time, such as a big outstanding balance on their credit card.
Logically, people should use these pots of money to pay off the extortionate credit card debt first – then their overall personal finances will be considerably healthier.
But when this is suggested to them they often baulk. Those little pots are seen as sacrosanct. Many say they are a useful way of ensuring financial self-discipline – suggesting that if they didn’t have a special mental cash pot for Christmas presents, for instance, they might not save at all for the festive season.
The irrationality can work in a different way too. If people can borrow cheaply today and something is likely to be more expensive tomorrow, it can make sense for people to do so rather than save out of their income and use their income to service the new debt instead.
Financial advisers warn people against the habit of mental accounting, regarding it as a poor way for people to manage their money. They urge people to think of their personal finances in the round.
But perhaps they should warn government ministers too. Theresa May floated the idea of Treasury-backed “infrastructure bonds” in a speech in July and the Government is reportedly developing a plan to issue such bonds to help pay for new state spending for the upkeep and construction of new power stations, roads, bridges, airports, and rural broadband connections. The scheme could be unveiled by the Government in the Autumn Statement on 23 November.
The assumption is that the Government will create long-term bonds which will then be sold to private sector investors such as pension funds and insurance companies. The Government will spend the proceeds on constructing the new infrastructure and pay the annual interest on the bonds out of general taxation.
You might ask what the difference is between infrastructure bonds and the Government simply issuing normal government debt – Gilts – and selling the Gilts to the capital markets. And well you might, because the answer is that, in practice, there is no difference.
The Government would have to guarantee that the bonds will be repaid in full, making them a “safe asset” just like Gilts. The only difference is that the Government might voluntarily pay a higher coupon on the infrastructure bonds than Gilts to make them look initially more attractive. Yet the debt would likely soon trade in the secondary market at a price which adjusted away this interest rate differential with Gilts.
Moving money into different mental pots, paying more than necessary: the analogies to an individual’s mental accounting are clear.
What experts have said about Brexit
What experts have said about Brexit
1/11 Chancellor of the Exchequer Philip Hammond
The Chancellor claims London can still be a world financial hub despite Brexit “One of Britain’s great strengths is the ability to offer and aggregate all of the services the global financial services industry needs” “This has not changed as a result of the EU referendum and I will do everything I can to ensure the City of London retains its position as the world’s leading international financial centre.”
2/11 Yanis Varoufakis
Greece's former finance minister compared the UK relations with the EU bloc with a well-known song by the Eagles: “You can check out any time you like, as the Hotel California song says, but you can't really leave. The proof is Theresa May has not even dared to trigger Article 50. It's like Harrison Ford going into Indiana Jones' castle and the path behind him fragmenting. You can get in, but getting out is not at all clear”
3/11 Michael O’Leary
Ryanair boss says UK will be ‘screwed’ by EU in Brexit trade deals: “I have no faith in the politicians in London going on about how ‘the world will want to trade with us’. The world will want to screw you – that's what happens in trade talks,” he said. “They have no interest in giving the UK a deal on trade”
4/11 Tim Martin
JD Wetherspoon's chairman has said claims that the UK would see serious economic consequences from a Brexit vote were "lurid" and wrong: “We were told it would be Armageddon from the OECD, from the IMF, David Cameron, the chancellor and President Obama who were predicting locusts in the fields and tidal waves in the North Sea"
5/11 Mark Carney
Governor of Bank of England is 'serene' about Bank of England's Brexit stance: “I am absolutely serene about the … judgments made both by the MPC and the FPC”
6/11 Christine Lagarde
IMF chief urges quick Brexit to reduce economic uncertainty: “We want to see clarity sooner rather than later because we think that a lack of clarity feeds uncertainty, which itself undermines investment appetites and decision making”
7/11 Inga Beale
Lloyd’s chief executive says Brexit is a major issue: "Clearly the UK's referendum on its EU membership is a major issue for us to deal with and we are now focusing our attention on having in place the plans that will ensure Lloyd's continues trading across Europe”
8/11 Colm Kelleher
President of US bank Morgan Stanley says City of London ‘will suffer’ as result of the EU referendum: “I do believe, and I said prior to the referendum, that the City of London will suffer as result of Brexit. The issue is how much”
9/11 Richard Branson
Virgin founder believes we've lost a THIRD of our value because of Brexit and cancelled a deal worth 3,000 jobs: We're not any worse than anybody else, but I suspect we've lost a third of our value which is dreadful for people in the workplace.' He continued: "We were about to do a very big deal, we cancelled that deal, that would have involved 3,000 jobs, and that’s happening all over the country"
10/11 Barack Obama
US President believes Britain was wrong to vote to leave the EU: "It is absolutely true that I believed pre-Brexit vote and continue to believe post-Brexit vote that the world benefited enormously from the United Kingdom's participation in the EU. We are fully supportive of a process that is as little disruptive as possible so that people around the world can continue to benefit from economic growth"
11/11 Kristin Forbes
American economist and an external member of the Monetary Policy Committee of the Bank of England argues that the economy had been “less stormy than many expected” following the shock referendum result: “For now…the economy is experiencing some chop, but no tsunami. The adverse winds could quickly pick up – and merit a stronger policy response. But recently they have shifted to a more favourable direction”
A generous way of looking at the infrastructure bonds project is that they provide some helpful incentives for the Government, just like mental accounting does for individuals – encouraging ministers to spend more on infrastructure by nominally ring-fencing the money raised through their sale.
There is also an argument that if the bonds are issued via a national infrastructure bank there could be a structural upward shift in the availability of funds for state infrastructure projects.
A less generous interpretation is that ministers are really engaged in form of self-deception; that they are trying to convince themselves they have not effectively scrapped George Osborne’s squeeze on state infrastructure funding.
Despite the former Chancellor’s professed love of infrastructure spending, his last Budget in March had pencilled in a fall in public sector net investment to just 1.5 per cent of GDP in 2019-20 (down from 1.9 per cent today). Theresa May and Philip Hammond are sensibly jettisoning that false economy.
The markets are unlikely to be fooled by Treasury accounting tricks. When your bank does a credit check on you, it does not distinguish between your various mental pots of money and your debts. It looks at your balance sheet in the round. Similarly, the financial markets will not distinguish between state-guaranteed infrastructure bonds and Gilts: they are all government debt.
And there’s nothing to be ashamed of in increasing the national debt when interest rates are still very low, provided the money is spent on projects which increase the future productive capacity of the UK economy, as good infrastructure projects will.
The pity is that ministers and civil servants are wasting time and energy devising new ways to package up state borrowing when they should be concentrating on making sure they choose the right building projects to finance.