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Shock Propagation and Banking Structure.
Chester S. Spatt
Consumption Taxes and Corporate Investment. Does It Pay to Pay Attention? Evidence from a Simple Specification Test. Valuing American Options by Simulation: A Simple Least-Squares Approach. Evidence from Syndicated Loans. SFS Finance Cavalcade The goal of the SFS Finance Cavalcade is to provide a setting that produces the kind of in-depth participation of a smaller conference while accommodating the variety of papers of a larger one. Email Alerts Register to receive table of contents email alerts as soon as new issues of The Review of Financial Studies are published online.
Finally, the automatic enrollment default may service as an endorsement implicit advice that individuals should be saving. These results collectively motivated the adoption of provisions in the Pension Protection Act of that encourage U. In simulations, they find that neutralizing the impact of advertising on preferences results in price-elastic demand. These results suggest that centralized information provision and regulation of both disclosure and advertising are important to ensure that individuals with limited financial capabilities have access to the information necessary for effective decision making and to minimize their confusion or persuasion by questionable advertising tactics.
In the government attempted to increase fee transparency in the privatized social security system by introducing a single fee index which collapsed multiple fees loads and fees on assets under management into one measure. Prior to the policy, investor behavior was inelastic to either type of fee or, indeed, any measure of management costs.
In contrast, after the policy, demand was very responsive to the fee index. This example suggests that investors can be greatly helped by policies that simplify fee structures and either advertise fees or require that they are disclosed in an easy-to-understand way. This example also highlights the potential pitfalls of ill-conceived regulations. Although the policy shifted demand, it had little impact on overall management costs. This is because the index combined fees according to a formula and firms could game the index by lowering one fee while raising another.
Not surprisingly, firms optimized accordingly another example of obfuscated pricing as discussed earlier. The government eventually responded by restricting asset managers to charging only one kind of fee, obviating the need for a fee index. Hastings in progress evaluates two field experiments as part of a household survey the EERA referenced in Table 2 to further understand the impact of information and incentives on management fund choice by affiliates of Mexico's privatized social security system. Households in the survey were randomly assigned to receive simplified information on fund manager net returns the official information required by the social security system at the time presented as either a personalized projected account balance or as an annual percentage rate.
In addition to that treatment, households were randomly assigned to receive a small immediate cash incentive for transferring assets to any fund manager that had a better net return or a higher projected personal balance. Rather, individuals who receive the small cash incentive are more likely to change fund managers for the better regardless of the type of information received.
These preliminary results suggest that incentives that both address procrastination and that are tied to better behavior may be more effective than financial education as financial education does not carry with it any incentive to act. We note that these results are still short-run and preliminary as they are based on a follow-up survey. Final results will depend on administrative records for switching which are not subject to problems inherent in self-reports.
They suggest that evaluating consumers along two dimensions, their preference heterogeneity and their level of financial sophistication or, in the parlance of this paper, their financial literacy , may help narrow the set of appropriate policy levers for improving consumer financial outcomes. At one extreme, take the case of stored value cards, a product used by a large number of unsophisticated consumers and for which consumer preferences are relatively homogeneous.
This is likely to be more efficient and cost effective than attempting to educate consumers in an environment in which firms are less stringently regulated. In contrast, if consumers are financially knowledgeable and have heterogeneous preferences other approaches may make more sense. Although Campbell et al. At the other extreme, there are products like hedge funds that cater to individuals with tremendous preference heterogeneity and that require a sizeable amount of financial knowledge for effective use.
The latter condition may seem like a perfect reason to justify financial education. We would counter, however, that in such a context it may be difficult for public policy to effectively intervene in providing the level of financial education that would be required. For products for which extensive expertise is required, it may be more efficient to restrict markets to those who can demonstrate the skills requisite for appropriate and effective use.
Overall, the literature suggests that there are many alternatives to financial education that can be used to improve financial outcomes for consumers: Although none of the studies that we reviewed here ran a horse race between these other approaches and financial education, many of them show larger effects than can be ascribed to financial education in the existing literature. Expanding these studies to other relevant markets such as credit card regulation, payday loan regulation, mortgages, and car or appliance loans present important next steps in understanding how best to improve consumer financial outcomes.
In this paper, we have evaluated the literature on financial literacy, financial education, and consumer financial outcomes. This literature consistently finds that many individuals perform poorly on test-based measures of financial literacy. However, there is little consensus in the literature on the efficacy of financial education. The existing research is inadequate for drawing conclusions about if and under what conditions financial education works. The directions for future research depend in part on the goal at hand.
If the goal is to improve financial literacy, the directions for future research that follow hinge on financial literacy and the role of financial education in enhancing financial literacy. One set of fundamental issues relate to capabilities. What are the basic financial competencies that individuals need? What financial decisions should we expect individuals to successfully make independently, and what decisions are best relegated to an expert? To draw an analogy, we don't expect individuals to be experts in all domains of life—that is the essence of comparative advantage.
Most of us consult doctors when we are ill and mechanics when our cars are broken, but we are mostly able to care for a common cold and fill the car with gas and check our tire pressure independently. What level of financial literacy is necessary or desirable? And should certain financial transactions be predicated on demonstrating an adequate level of financial literacy, much like taking a driver's education course or passing a driver's education test is a prerequisite for getting a driver's license.
If so, for what types of financial decisions would such a licensing approach make most sense? Another set of open questions relate to measurement. How do we best measure financial literacy? Which measurement approaches work best at predicting financial outcomes? And what are the tradeoffs implicit in using different measures of financial literacy e. A third set of issues surrounds how individuals acquire financial literacy and the mechanisms that link financial literacy to financial outcomes. How important are skills like numeracy or general cognitive ability in determining financial literacy, and can those skills be taught?
To the extent that financial literacy is acquired through experience, how do we limit the potential harm that consumers suffer in the process of learning by doing? Is financial education a substitute or a complement for personal experience?
We need much more causal research on financial education, particularly randomized controlled trials. Does financial education work, and if so, what types of financial education are most cost effective? Much of the literature on financial education focuses on traditional, classroom based courses.
Is this the best way to deliver financial education? More generally, how does this approach compare with other alternatives? Is a course of a few hours length enough, or should we think more expansively about integrated approaches to financial education over the lifecycle? Or, on the other extreme, should financial education be episodic and narrowly focused to coincide with specific financial tasks? There are many other ways to deliver educational content that could improve financial decision making: How effective and how cost effective are these different delivery mechanisms, and are some better-suited to some groups of individuals or types of problems than others?
Should the content of financial education initiatives be focused on teaching financial principles, or rules of thumb? In the randomized controlled trial of two different approaches to financial education for microenterprise owners in the Dominican Republic discussed earlier, Drexler et al. How robust is this finding? Even if we can develop effective mechanisms to deliver financial education, how do we induce the people who most need financial education to get it?
School-based financial education programs have the advantage that, while in school, students are a captive audience. But schools can only teach so much. Many of the financial decisions that individuals will face in their adult lives have little relevance to a year-old high school student: How do we deliver financial education to adults before they make financial mistakes, or in ways that limit their financial mistakes, when we don't have a captive audience and financial education is only one of many things competing for time and attention?
Finally, what is the appropriate role of government in either directly providing or funding the private provision of financial education? If financial education is a public good Hastings et al. If so, what form would that take? If instead of improving financial literacy our goal is to improve financial outcomes, then the directions for future research are slightly different. The overarching questions in this case center around the tools that are available to improve financial outcomes. This might include financial education, but it might also include better financial market regulation, different approaches to changing the institutional framework for individual and household financial decision making, or incentives for innovation to create products that improve financial outcomes.
With this broader frame, one important question on which we have little evidence is which tools are most cost effective at improving financial outcomes? For some outcomes, the most cost effective tool might be financial education, but for other outcomes, different approaches might work better. Moreover, automatic enrollment and contribution escalation are less expensive to implement than financial education programs. What approaches to changing financial behavior generate the biggest bang for the buck, and how does financial education compare to other levers that can be used to change outcomes?
Despite the contradictory evidence on the effectiveness of financial education, financial literacy is in short supply and increasing the financial capabilities of the population is a desirable and socially beneficial goal. We believe that well designed and well executed financial education initiatives can have an effect.
But to design cost effective financial education programs, we need better research on what does and does not work. We also should not lose sight of the larger goal—financial education is a tool, one of many, for improving financial outcomes. Financial education programs that don't improve financial outcomes can hardly be considered a success. Unfortunately, we have little concrete evidence to provide answers.
We have a pressing need for more and better research to inform the design of financial education interventions and to prioritize where financial education resources can be best spent. To achieve this, funding for financial education needs to be coupled with funding for evaluation, and the design and implementation of financial education interventions needs to be done in a way that facilitates rigorous evaluation.
We thank Daisy Sun for outstanding research assistance.
Areas of Study
When citing this paper, please use the following: Annual Review of Economics 5: NBER working papers are circulated for discussion and comment purposes. Madrian, and William L. See Hastings, Neilson and Zimmerman in progress for details on the survey and data. There is also a large literature in the economics of education documenting the fact that large increases in real spending per pupil in the United States has led to no measurable increase in knowledge as measured by ability to answer questions on standardized tests.
Aggregated over 30 million account holders, this is a large savings even before allowing for secondary competitive effects, and in equilibrium it is virtually costless to implement. The following datasets with financial literacy questions that are referenced in this article are currently publically available. Health and Retirement Survey: National Financial Capability Study: National Center for Biotechnology Information , U. Author manuscript; available in PMC Aug Hastings , Brigitte C. Madrian , and William L. Author information Copyright and License information Disclaimer.
See other articles in PMC that cite the published article. Abstract In this article we review the literature on financial literacy, financial education, and consumer financial outcomes. After 5 years, how much do you think you would have in the account if you left the money to grow?
After 1 year, would you be able to buy more than today, exactly the same as today, or less than today with the money in this account? More than today Exactly the same as today Less than today Don't know Refused Risk Diversification Do you think that the following statement is true or false: True False Don't know Refused. Open in a separate window. The answer categorized as correct is italicized in the last column.
Footnotes NBER working papers are circulated for discussion and comment purposes. The effects of perceived and actual financial knowledge on credit card behavior. Inst, Indian State Univ. Wealth accumulation and the propensity to plan. Understanding the incentives of commissions motivated agents: Agnew J, Szykman L.
Asset allocation and information overload: The age of reason: Payday loans and credit cards: Learnng in the credit card market. Reserve Bank Chicago; The tradeoff between mortgage prepayments and tax-deferred retirement savings. Adverse selection in the credit card market. Banks J, Oldfield Z. Barber B, Odean T. Are individual investors tax savvy? The case for behaviorally informed regulation.
Behavioral Foundations of Policy. Financial education — Does it work and how do we know? Research findings from a study of financial education among soldiers. Bergstresser D, Poterba J. Asset allocation and asset location: The effects of financial education in the workplace: The importance of default options for retirement saving outcomes: Kay S, Sinha T, editors.
Lessons from Pension Reform in the Americas. The economics and psychology of personal Traits. Boyce L, Danes S. Results of a Nationwide Test. High School Student Consumer Knowledge: College Student Consumer Knowledge: The Results of a Nationwide Test. Measuring the financial sophistication of households.
Research Publications
The regulation of consumer financial products: Forced sales and house prices. Unpacking the casual chain of financial literacy. Why does the law of one price fail? An experiment on index mutual funds. Cognitive abilities and portfolio choice. The Effect of Education on Financial Behavior. Harvard Business School; The impacts of mandatory financial education: Center for financial Security; Financial education and counseling -- still holding promise.
Cunha F, Heckman J. The technology of skill formation. Estimating the technology of cognitive and noncognitive skill formation. Financial Literacy and Rules of Thumb. Duarte F, Hastings JS. Fettered consumers and sophisticated firms: Duflo E, Saez E. The role of information and social interactions in retirement plan decisions: Implications of information and social interactions for retirement saving decisions.
Michell O, Utkus S, editors. Pension Design and Structure: New Lessons from Behavioral Finance. A model of add-on pricing. Do children lose more than a home? The effects of foreclosure on children's education outcomes. Junior Achievement, a History: Essays in Positive Economics. Gabaix X, Laibson D. Shrouded attributes, consumer myopia, and information suppression in competitive markets.
Journal Rankings on Finance
Gale W, Levine R. Center for Retirement Research Boston College; Gartner K, Todd RM. Financial literacy and subprime mortgage delinquency: Reserve Bank Atlanta; Gentzkow M, Shapiro J. Media bias and reputation. What drives media slant? Investor competence, trading frequency, and home bias. Do smart investors outperform dumb investors? Do liquidity constraints and interest rates matter for consumer behavior?
Financial literacy, information, and demand elasticity: How financial literacy and impatience shape retirement wealth and investment behaviors. Advertising and competition in privatized social security: Persuasive Advertising for a SavingsAccount. Hathaway I, Khatiwada S. Do financial education programs work? Reserve Bank Cleveland; Financial education and economic development.
Aging and strategic learning: Reserve Board Governors; Defining and measuring financial literacy. Jappelli T, Padula M. Investiment in financial literacy and savings decision. Kimball M, Shumway T. Investor sophistication and the participation, home bias, diversification, and employer stock puzzle. Saving and the effectiveness of financial education. Lusardi A, Mitchell OS. Financial literacy and planning: Pension Research Council; Financial literacy and retirement planning: Michigan Retirement Research Center; How ordinary consumers make complex economic decisions: Lusardi A, Tufano P.
Debt literacy, financial experiences, and overindebtedness. Survey of the States: Optimal financial knowledge and wealth inequality. The power of suggestion: Financial literacy of high school students. In Handbook of Consumer Finance Research. Jumpstart Coalition; Washington D. A literature Review on the effectiveness of financial education.
Reserve Bank Richmond; Meier S, Sprenger C. Present-biased preferences and credit card borrowing. Survey of financial literacy in Washington state: Center, Washington State Univ; The market for financial advice: Are investors reluctant to realize their losses? Analysis of Issues and Policies. Inappropriate confidence and retirement planning: Teaser rate offers in the credit card market: Servon LJ, Kaestner R. Consumer financial literacy and the impact of online banking on the financial behavior of lower-income bank customers.
Essays in behavioral household finance. Stango V, Zinman J. Exponential growth bias and household finance. The evolution of the credit counseling industry. The Economics of Consumer Credit. Thaler R, Benartzi S. Thaler R, Sunstein C.