Let’s talk about… financial education

This post and then this post passed by in succession in my rss reader this afternoon. Since its hard work to make real connections between things, I’ll let this random pairing do the work for me.

First reaction to Mike’s post on financial education: education is paternalism. To wit, Mankiw’s views of economics education are exactly like a Marxist’s need to raise his students’ consciousnesses. We have views we think our students should have. There are “good” views and there are “bad” views. I think we’re going to have to live with this sort of paternalism.

Second, financial education, and personal finance in particular, IS NOT economic education. Personal finance is about individuals making decisions about particular goods and services. Economics is about how many people’s decisions aggregate up into market behavior. Like waaay different.

Third — and here’s the lazy connection with the Robin Hanson post — financial education is just an instance of rationality education. If students could learn to be more rational (and they use that reason), they would be better consumers of finance when they get out in the world. Because some students aren’t smart enough and most aren’t so inclined, they can’t be taught to be more rational in general. So, financial education needs be a set of rules of thumb with a sprinkling of general principles.

Example: everything you need to know about interest rate calculations is taught to you in 6th grade math class. Because students are too dumb or disinclined to care, they don’t make the connection. So we need to teach them specifically how to calculate the interest payments on credit cards and point out to them how many big screen tv’s they won’t get to buy if they rack up their credit card balances.

The guiding principle would be to teach rules of thumb that, if followed, would lead to people making the least bad mistakes, e.g. its better to scare the bejeezus out of students about credit cards even if it leads them to forgo getting them. That said, people learn from mistakes so we shouldn’t aim to prevent all mistake making.

Aside: I consider myself a pretty staunch anti-paternalist… the big fight with the Real Scientist right now is over whether we should cut checks to poor people or buy health care for them. She says, and I’m paraphrasing only a little, “they’re too dumb to buy health insurance themselves so we have to do it for them.” I say that I’d hate to be treated that way, like a child, and so we should just give income subsidies to the poor and let them figure out what goods and services they need to buy.

Anyway, I’m an anti-paternalist EXCEPT when it comes to education and specifically when it comes to teaching people how to think. To me, it better for people to learn to think for themselves than for others to think for them. A second best: people should at least act like they’re thinking for themselves (i.e. following rules of thumb). At least in this case, there’s at least a chance that people will learn to think for themselves and become more rational.

In all three cases, though, paternalism is involved.

10 thoughts on “Let’s talk about… financial education”

  1. You learned the Black-Derman-Toy model of interest rates in the 6th grade? You’d need some sort of interest rate model in mind to value a variable interest rate mortgage, and that’s a popular quant one. I’m curious how you did closed form solutions for the jumps credit card rates exhibit,if you didn’t use simulations.

    Your answer has a bit of Macro supremacy to it, no? There are plenty of people who deal with decision making under uncertainty in economics that could form a theoretical basis for personal finance. Fatih Guvenen has a model of lifetime earnings shocks, and the parts of it that are relatable to consumption smoothing under uncertainty influences my thoughts when it comes to consumer finance, and he’s Macro at Minnesota. He probably didn’t mean to, but it’s a piece someone could slice out of a macro model and think through how it relates to individuals. My current thought is that the real divide here is the practitioner’s line, fwiw.

  2. Yeah, decision theory is not economics (if its applied to individual behavior). It rightfully belongs to the psychologists. I think their experiments have proven, without a doubt, that axiomatic choice theory is not a good model of individual behavior. This fact has approximately zero implications for economics. Emphatically, we (economists) know nothing about how individuals make their decisions. We should be (but mostly aren’t) content to know they, when aggregated, often act *as-if* they were rational and responding to incentives.

    I wouldn’t advise using a macro model to help you understand an individual’s behavior. It might help you understand “average” behavior or good policy, but that’s no use for someone trying to figure out which financial products to buy. What’s rational for the individual may not be for the aggregate (e.g. paradox of thrift) and what explains aggregate behavior may not explain individual behavior (e.g. rational agents). Its possible that the assumptions about individual behavior that correspond to the tightest empirical fit of the macro model are not consistent with the “real” individuals’ decision making process. I’m thinking in particular of the Cambell and Cochrane 2000 paper I just read this morning.

    That said. I don’t know the paper you’re referring to.

    Regarding interest rate calculations: I learned about percentages and I learned how to multiply them with other numbers (maybe this was earlier than 6th grade). This is all you need to know to figure out how much of your payment is going to interest (and how little is going to paying off the principle).

  3. Regarding silly-complex mortgages or whatever: a rule-of-thumb (one that I use) is that if something is really confusing and you don’t know what you’re agreeing to, then you shouldn’t agree to it. If followed, this rule-of-thumb would drastically reduce the demand for such mortgages and I imagine mortgage providers would have to respond.

    Side note: I don’t use this rule-of-thumb when it comes to software EULAs. I always have a vague sense of unease when I click “I agree”. But I rationalize this by telling myself that EULAs are unenforceable contracts (at least under the constitutional regime in my head).

  4. Also demand for drivers’ licenses, new cars, full time jobs, credit cards, bank accounts, property rentals, cable TV, cell phones, insurance of any kind…

    It’s amazing how much of modern society runs on a kind of *wink and nod* model around contracts and licensing terms.

  5. “they’re too dumb to buy health insurance themselves so we have to do it for them.” I say that I’d hate to be treated that way, like a child, and so we should just give income subsidies to the poor and let them figure out what goods and services they need to buy.”

    This isn’t how I’ve read the health care debate over the past two years at all. This argument would hold more credibility if insurance plans were sold like fruit from a fruit stand.

  6. push, you better be doing serious decision theory because you need micro-structure to discipline your macro behavior, otherwise it’s all up for grabs (SMD).

    Without that you’re left with “quasi-natural experiments” and VARs and a whole bunch of other stuff that’s conclusive how?!

  7. “Micro” foundations are a disciplining tool (and they might help us escape the Lucas Critique). We should have structural models of the economy and that structure shouldn’t change with policy, but that doesn’t mean we need to explain individual behavior.

  8. Well, in all the economics I know, that policy invariant structure is tastes+technology+expected utility maximization, i.e. … individual behavior.

    What structure did you have in mind?

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