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February 16, 2012

Marshmallows and the Federal Reserve

At Reason, Katherine Mangu-Ward interviews John Tierny, co-author of Willpower: Rediscovering the Greatest Human Strength. It’s wide-ranging and fascinating conversation, but it begins with the Marshmallow Test, an experiment “where 4-year-olds would be given a marshmallow. They were told they could eat it but if they waited 15 minutes they would get two marshmallows… The kids who managed to resist the marshmallow did much better in school, did much better in life.”

Obviously, self-control is important. But we can’t dismiss two factors in the experiment that are less certain in real life.

Namely, security and trust…

1. Security: The children would have no reason to believe that, after eight minutes, someone would come and steal the one marshmallow they’re saving.
2. Trust: They had no reason to distrust the adult who made the offer. If they waited the 15 minutes, they were sure to get the second marshmallow.

The adult was not going to say, “I changed my mind; you don’t get a second one.”

Now think what would happen if the children were told, “If you wait 15 minutes, you MIGHT get a second marshmallow, but who knows?”

Would you criticize the children who ate their marshmallow immediately? The unpredictability of the reward made a correct decision regarding their marshmallow “saving” impossible. There are no right decisions, only guesses.

That’s more like how real life works. Robert Higgs has explained how the Federal Reserve is hurting those who “saved their marshmallows.”  Higgs shows that thanks to Fed policy, inflation-adjusted interest income has 78% of the purchasing power of interest income of eleven years ago. People who have prudently saved and made only the most cautious investments, are seeing their retirement income depleted.

Such people, admittedly, are likely STILL better off than those who…

  • Didn’t save at all
  • Put all their eggs in one basket
  • Or who were lured into “too good to be true” investments

Yet, the Federal Reserve has made our financial system LESS secure and LESS trustworthy — the opposite of its intended purpose. It is only to be expected, then, that when the rewards for self-control diminish, fewer people will “save their marshmallows.” When even thrifty savers are punished by the Fed, how is anyone supposed to make rational financial decisions? 

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