Inflation: Why household happiness falls when prices rise

Inflation continues to accelerate in the eurozone. In France, consumer prices rose by 6.1% yoy in July, according to the latest data released by INSEE. What consequences for well-being and satisfaction can be expected if the purchasing power of households comes under increasing pressure? Decoding with Mickaël Mangot, specialist in behavioral economics and economics of happiness, teacher at Essec and director general of the Institute of the Economy of Happiness.

Inflation is a legitimate concern for many households, particularly the humblest, who are already struggling to make ends meet. Do we have any idea what effect this may have on people’s happiness?

Yes, we have a number of happiness economics studies looking at the links between inflation and happiness. Unsurprisingly, they conclude that inflation is detrimental to happiness. When consumer prices rise rapidly, people’s life satisfaction tends to fall.

Why are rising prices bad for happiness?

Three mechanisms have been observed by the researchers and help explain this relationship. First, of course, there is the decline in purchasing power. This leads to a lower consumption of leisure activities (cinema, restaurant, vacation, etc.), which in normal times have a positive effect on happiness, at least in the short term.

Inflation also creates fears of uncertainty about living standards. Finally, inflation can feed the uncomfortable feeling of being “cheated”. When prices rise sharply, one can feel deceived by the manufacturers or traders into believing that the price rise is not fully justified by the rise in the price of the raw materials. You can also be bitter towards your employer if he does not react positively to requests for a salary increase and you have doubts about the reasons given (e.g. maintaining competitiveness).

They say inflation forces us to consume less. How are consumption and life satisfaction related?

Consuming can help increase happiness, but only occasionally. A consistent finding from the science of happiness is that people adapt quickly to almost any type of change in their lives. This applies, for example, to the purchase of durable goods (a new car, a new house, etc.), where the increase in happiness generated lasts only a few months (for the car) or at best a year or two (the house). . Compare this to the term of the loan…

However, there are some types of consumption that shape happiness more sustainably, such as consumption for experiences (new things we do that contribute to our identity, such as travel, shows or sporting challenges) or multiple recreational consumption. If we systematically cut these budgets when inflation reduces purchasing power, the consequences for happiness can be significant.

Does inflation leave long-term traces on happiness and economic behavior?

Yes, we have observed that people who have experienced episodes of high inflation in the past are less satisfied with their lives over the long term than people with similar characteristics who have not experienced the same episodes of high inflation. The idea is that as these people remember those times of high economic uncertainty, this fuels the perception that economic disorder may return. Conversely, people who have never experienced high inflation ignore what the history books say and neglect the risk of inflation until… it manifests itself. Personal experiences and historical facts that have not been experienced do not have the same weight in perception.

We can observe the same phenomenon in saving behaviour. People who have experienced periods of sharply accelerated inflation later have fewer fixed income investments because they vividly remember their crash during periods of rising prices and interest rates.

With prices rising, central banks are only just beginning to raise interest rates at the risk of provoking a recession. Are recessions bad for happiness?

Yes, without a doubt. Average happiness in a country follows the curve of short-term growth. It rises when growth accelerates and falls during recessions. The relationship is also asymmetrical. The effects of negative growth on happiness are greater than those of positive growth.

Why Do Recessions Diminish Happiness?

Recessions lower (average) happiness, particularly because they feed the rise in unemployment. However, the satisfaction of the unemployed is greatly reduced compared to active workers (with comparable characteristics). It is clear that personal unemployment is a very negative bliss shock that we do not fully adapt to and that leaves long-term consequences.

The rise in unemployment severely affects average happiness because it impacts both those who lose their jobs and those who fear losing them. Recessions create fear of the risk of job loss for many other workers.

Finally, recessions contribute to income stagnation, a negative wealth effect for those who see their financial savings fall with stock market prices, and an increase in retirement savings. All of this leads to reduced consumption (especially of durable goods and leisure) and thus to a short-term potential for happiness.

Do recessions have a positive effect on anyone?

Paradoxically yes. Several counterintuitive positive effects of recessions have been observed. People who were unemployed before the recession tended to experience some relief. It has even been observed that when unemployment rates are very high (over 20% in one job sector) there is no longer any psychological penalty for being unemployed! When the unemployment rate is very high, unemployment is no longer experienced as a social stigma.

Another amazing phenomenon, recessions can improve physical and mental well-being because the reduction in working hours (with the reduction in overtime) provides more time for…sleeping, cooking, exercising, or caring for children.

Finally, recessions appear to have a long-term positive effect on well-educated young people who start their careers during these difficult times. After a chaotic entry into the labor market, the expectations are lower afterwards – in other words, they are less megalomaniac! This renewed humility leads them later to be more satisfied with their work and life.