There is a key question asked in the monthly U.S. consumer sentiment survey by the Institute of Social Research (ISR) at the University of Michigan: "One year from now will your financial situation be better, worse or about the same?"
The answer to this question determines the openness of the consumer to spend or save in the current economic climate and is an early warning signal toward where the economy is headed. If the consumer believes that his family's take home pay will steadily increase over the next year, the family will likely continue to spend. This is an important concept to understand when designing government stimulus packages.
For example, one explanation for why tax rebates don't have a bigger impact is that they don't affect what Milton Friedman called people's "permanent income." Friedman argued that people's spending is determined by what they think their income will be over time: they change their spending habits only if they think they're going to be permanently wealthier or poorer.
You might think that handling people a big chunk of change is a perfect way to get them to spend it. But it isn't, because people don't treat all windfalls as found money. Instead, in the words of the behavioral economist Richard Thaler, people put different windfalls in different "mental accounts," which in turn influences what they do with the money. The size of the windfall matters a lot: the bigger the windfall, the more likely it is to be saved.
The key factor in these kinds of distinctions, Thaler's work suggests, is whether people think of a windfall as wealth or as income. If they think of it as wealth, they're more likely to save it, and if they think of it as income, they're more likely to spend it. In Thaler's words, "People tend to consume from income and leave perceived wealth alone."
So what does this mean for making a rebate work? You want to give them small amounts over time. And you want the rebate to show up as an increase in people's take home pay, because an increase in steady income is more likely to translate into an increase in spending.
Source: THE NEW YORKER, January 26, 2009