This week with the announcement of Budget 2026, the Government managed to pull off the most unenviable of political paradoxes; they outlined what economists warn is an unsustainably large increase in spending, without making many people happy.
One reason for the negative reactions is the removal of previous so-called once-off cost-of-living supports. Because these measures provided significant universal supports and were repeated in multiple budgets, their absence now feels like a loss in income for individuals. So even those on the higher end of the income distribution scale may think they are worse off after this budget, whether or not that is actually true.
When it comes to our finances, there is always an objective reality; financial facts that are easily demonstrated by our bank balance, salary, or net worth. However, for many people there is a disconnect between their financial reality and their perceived financial status, a phenomenon the internet has dubbed “money dysmorphia”. It can manifest as people overspending and borrowing to sustain unaffordable lifestyles, or as wealthy individuals underestimating their financial position relative to others. These delusions occur because people tend to lack objectivity in their evaluations, especially where money is concerned. Irrelevant factors can impact how we feel or think about our financial situation, influencing our perceptions, and resulting in behavioural biases.
How we think about money can lead us to irrational choices when we engage in a process called “mental accounting”. Money that we hold in our accounts is fungible, meaning that every €1 we possess is exactly the same as every other €1. However, we tend to treat money differently depending on its source. If we receive an unexpected windfall, we put it into a separate mental “account” from money that we have earned, often to spend it on a treat or luxury good.
RM Block
How we frame losses of money also changes how we feel about spending. If we combine multiple expenses into one big payment we feel much better about the expenditure than when we spend the same amount over multiple transactions. For example, booking an all-inclusive holiday can be more expensive than organising and paying for each element separately, but one large payment feels less painful than multiple smaller ones. Additionally, purchasing the holiday in advance can feel like an investment, and when we get there it feels like a free holiday.
[ Are you living beyond your means? You may have money dysmorphiaOpens in new window ]
Similarly, payments made by card decouple the cost from the purchase of a good – particularly with credit cards, where a month of spending is amalgamated into one single payment. Last year Irish consumers spent almost €103 billion in card transactions. We can feel the loss of money less keenly when we make purchases this way.
Another common reason why we deviate from rationality in spending decisions is that we tend to evaluate choices in relation to a particular reference point, rather than objectively considering the costs and benefits. Common reference points include the status quo – what we already have or do; and the social norm – what is common or socially acceptable. My friends might have higher incomes than me, but I may still use their level of spending as my reference point. If they spend lots of money on expensive holidays or restaurants, this can lead me to spend beyond my means; this social norm acts as a shortcut in my decision-making process. Even if I realise I can’t afford their level of spending, it acts as an anchor for my evaluations. I’m pulled towards their spending level because I use it as a starting point and adjust downwards, rather than thinking objectively about what I should spend. This can lead me to spend more than I can afford.
Last year in Ireland there was a 31 per cent increase in the value of personal loans taken out for purposes such as holidays and special occasions. Given the average interest rate on these loans is about 10 per cent, it’s an expensive way to finance consumption and is unsustainable unless income is expected to rise in the future.
When everyone in a social group can afford expensive goods, the default level of spending can be high. Once this is the established norm, people have a tendency to go along with it, even if they would rather spend less. In fact, even when no one in the group is comfortable with the norm, it can be perpetuated due to a phenomenon known as pluralistic ignorance. This occurs when everyone incorrectly assumes that the others are all happy with the level of spending, when in reality they are not. Everyone thinks that they are the only one who feels they are overspending, but no one wants to voice this opinion and be in a perceived minority. So everybody conforms to the status quo level of spending, even though they would all prefer to reduce expenditure.
While our finances can objectively be good or bad, how we think about them can make them more or less so
Being in a peer group where everyone is financially well off can also distort people’s perceptions of their own wealth or income relative to the general population. We tend to use our social circle as our reference point in evaluating our own position, so even when we have a very high income, if we earn less than our friends or colleagues, we won’t feel wealthy. A recent survey by HSBC in the UK found that only 10 per cent of people earning more than £100,000 (€115,000) considered themselves wealthy, despite the fact that they are in the top 4 per cent of earners. Among high earners, an income of over £724,000 (€836,000) was the threshold to be considered wealthy.
Using social norms to guide your own spending decisions is also irrational because we have incomplete information about other people’s finances. Mostly, we only observe consumption spending; we can see that our neighbours bought a new car, or that our friend bought a designer handbag. Consumption spending on these so called “status goods” can sometimes be used to signal wealth and social status to others. However, how these purchases were paid for – perhaps by taking out a loan or running up credit card debt – is private information that isn’t usually shared.
In contrast, most investment decisions, such as increasing your pension payments or paying into a long-term savings account, are not observable to others, so these rational spending choices tend to be hidden. Therefore we don’t have the full picture when we use other people’s spending as a reference point for our own decisions.
“There is nothing either good or bad, but thinking makes it so,” reflected Shakespeare’s Hamlet. While our finances can objectively be good or bad, how we think about them can make them more or less so, creating a disconnect between perception and reality. Being aware of behavioural biases can help us overcome them and lead to better decision-making. Similarly, thinking about your own spending decisions independently rather than in relation to others can lead to better outcomes. Moreover, if you stop trying to keep up with the Joneses, you might just realise that the Joneses are trying to keep up with you.
Emma Howard is a lecturer in economics at Technological University Dublin. David McWilliams returns next week
