Why Small Changes Don't Change Behaviour: The Psychology Behind Economic Policy

The recent UK Budget raises a fundamental question: do incremental adjustments actually shift how people live, spend, and save?

 When Rachel Reeves delivered this week's Budget, bond markets responded within milliseconds. A few basis points movement in gilt yields prompted immediate analysis from hedge funds, pension managers, and currency traders. These sophisticated market participants are finely tuned to detect marginal changes—their profits depend upon it.

But here lies a profound disconnect. The mechanisms that drive bond market behaviour bear almost no resemblance to what drives consumer behaviour. And this distinction matters enormously for anyone seeking to understand how policy actually changes lives. 

The Two-Speed Economy of Perception

Consider what half a percentage point means to different actors. For a bond trader managing a £500 million portfolio, a 50 basis point shift represents material opportunity—profits or losses measured in millions. Their systems are calibrated to detect and respond to infinitesimal changes because their entire business model depends upon it.

 Now consider a household deciding whether to extend their mortgage or dip into savings. Does 0.5% on the base rate fundamentally alter that decision? Research suggests not. Studies examining consumer response to interest rate changes find that borrowing behaviour is remarkably inelastic to small movements. A 50 basis point cut in effective mortgage rates can indeed trigger a meaningful increase in home buying—one study found a 14% response—but crucially, this occurred because the rate change helped borrowers cross a hard threshold: the debt-to-income ratios that determine loan eligibility.

The operative word is threshold. Not gradient. Not marginal shift. Threshold.

Weber's Law and the Politics of Imperceptibility

The psychology of perception offers a robust framework for understanding this phenomenon. In the 1830s, Ernst Weber established what became known as the Just Noticeable Difference—the minimum change in stimulus intensity that a person can reliably detect. Weber's Law states that this difference is proportional to the original stimulus: the larger the starting point, the bigger the change required to register.

 This principle extends far beyond sensory psychology. In pricing research, the Just Noticeable Difference has direct commercial applications. Businesses understand that small price increases often pass unnoticed—and they exploit this systematically. Raise the price of a £10 item by 50p, and consumers barely register it. The same applies in reverse: small discounts on expensive items feel psychologically insignificant.

 This is precisely why fiscal drag—the freezing of tax thresholds—functions as such an effective "stealth tax." The OBR estimates that frozen income tax thresholds will raise over £38 billion annually by 2029/30, yet the mechanism operates below most taxpayers' perceptual threshold. Each year, wages edge upward while allowances remain static. The effect accumulates gradually, avoiding the psychological trigger that explicit rate increases would provoke.

From a behavioural perspective, this is extraordinarily clever policy design. From a democratic accountability perspective, it raises uncomfortable questions about governance by imperceptibility.

 What Actually Changes Behaviour?

If small changes don't shift behaviour, what does? The research points to several factors that genuinely move the needle:

Significant life events trump policy adjustments. The COVID-19 pandemic demonstrated this decisively. Studies found spending behaviour shifted by 60% or more during lockdown—not because of subtle policy incentives, but because circumstances demanded fundamental adaptation. People don't gradually adjust their consumption patterns in response to marginal tax changes; they recalibrate completely when external circumstances leave no alternative.

Hard thresholds matter more than gradual slopes. In mortgage markets, what drives behaviour is not the interest rate itself but whether applicants can cross eligibility thresholds. Debt-to-income ratios represent bright lines that determine access, not gradual cost-benefit calculations. Policy that shifts people across these thresholds—rather than merely improving their position within existing brackets—generates measurable behavioural response.

Psychological salience determines reaction. The research on tax compliance reveals that attitudes toward taxation are shaped far more by perceptions of fairness and trust than by calculations of penalty probability. Classic economic models predicted that rational actors would evade taxes whenever expected gains exceeded expected penalties. Yet compliance rates persistently exceed what these models predict, because psychological and social factors dominate purely financial calculations.

 The Implications for Policy Design

This analysis suggests that much economic policy operates in a zone of psychological irrelevance for ordinary citizens while being acutely relevant to financial markets. Bond traders, institutional investors, and currency speculators exist in a world of calibrated sensitivity—their business models demand it. Households operate in a world of attention scarcity, cognitive load, and threshold-based decision-making.

 This creates an uncomfortable asymmetry. The actors who respond most sensitively to Budget announcements are precisely those whose interests may diverge most sharply from the broader population. When policy becomes optimised for market reaction rather than behavioural impact, we risk creating the appearance of action while achieving minimal effect on the lives the policy ostensibly serves.

 The Budget's impact on gilt yields will be debated for weeks among professionals whose livelihoods depend on parsing such signals. The Budget's impact on whether families extend their mortgages, whether young people save for deposits, whether retirees adjust their spending—these questions require different analysis entirely.

 A Different Approach

If policymakers genuinely wish to shift behaviour—not merely market sentiment—the evidence suggests they need to think in terms of thresholds, not gradients. Meaningful change requires crossing psychological barriers, not nudging positions within existing decision frameworks.

This means accepting that bold, visible policy changes may be more effective than technically sophisticated but imperceptible adjustments. It means recognising that what moves markets is not what moves households. And it means acknowledging that the efficient market hypothesis, whatever its merits in pricing securities, offers limited guidance for understanding how 67 million people actually make economic decisions.

The bond markets will continue responding to basis points. Human beings, operating under cognitive constraints that haven't changed since Weber's experiments in the 1830s, will continue requiring something more substantial before they change course.