B. Douglas Bernheim’s Keynote Address: “A New Framework for Financial Education”

Key Concepts:

• Financial literacy and education
• Welfare economics and well-being
• Average treatment effects vs. welfare effects
• Exponential growth bias
• Substance vs. motivational rhetoric in education
• Moneymetric biases and deliberative competence
• Metacmpetence and self-assessed competence
• Unconventional costs and benefits of financial education
• Belief-based utility and intrinsic value of knowledge
• Idealized welfare analysis
• Non-comparability problem

1. Introduction and Motivation

• Professor Doug Bernheim's keynote focuses on directions for research in financial literacy and education, emphasizing the importance of measuring welfare effects rather than just changes in financial literacy or behavior.
• Bernheim acknowledges the explosion of interest in financial literacy over the last 20 years, but points out that his early work in the 1990s on the topic was largely ignored until Annamaria Lusardi brought significant attention to it.
• He initially stopped working on financial education due to the lack of a rigorous framework for thinking about welfare in this context, leading him to focus on behavioral welfare economics.

2. Does Financial Education Change Behavior for the Right Reasons?

• This section is based on Bernheim's work with Sandro Ambuehl and Annamaria Lusardi, published in the AER.
• The objective was to improve methods for evaluating policies like financial education that aim to improve decision-making quality.
• The study focused on compound interest due to its core financial concept, the well-established exponential growth bias, and its suitability for a brief educational intervention.
• Experiment Structure:
  • Stage 1: Educational intervention with a narrated video on compound interest from "A Random Walk Down Wall Street" by Malkiel and Ellis.
    • Treatment group received the compound interest section.
    • Control group received a different section from the same book.
    • Experiment A: No practice and feedback.
    • Experiment B: Included practice and feedback.
  • Stage 2: Valuation decisions using incentive-compatible mechanisms to elicit willingness to pay for interest-paying instruments (e.g., a $10 investment paying 2% interest per day compounded for 36 days).
  • Stage 3: Financial literacy assessment with exam-style questions specific to compound interest.
• Initial Results:
  • The treatment significantly improved literacy test scores in both experiments A and B, with no significant difference between them.
  • Valuations also increased significantly in both experiments, suggesting that the interventions had the desired effect on behavior.
  • Standard evaluation metrics would conclude that both interventions are effective and that practice and feedback are unnecessary.
• Further Investigation:
  • The intervention was broken down into two components: substance (conceptual explanations and the rule of 72) and motivational rhetoric (e.g., "Albert Einstein is said to have described compound interest as the most powerful force in the universe").
  • Additional versions of experiment A were conducted: one with substance only and one with rhetoric only.
  • Results showed that the substance primarily drove the improvement in test scores, while the rhetoric primarily drove the increase in valuations.
  • This disconnect between literacy and behavior suggests that people may be changing their behavior for the wrong reasons.
• Welfare Analysis:
  • The paper analyzes "moneymetric biases" by studying two objectively equivalent decision problems: one with naturally occurring complexity and one simplified to make the consequences transparent.
  • The "welfare relevant domain" is defined to include only the transparent choices.
  • The moneymetric bias is the difference in valuations between the complex and transparent problems.
  • CDF plots of the moneymetric bias revealed that experiment A (no practice and feedback) shifted the CDF to the right, indicating a welfare loss for some individuals.
  • Experiment B (with practice and feedback) showed that valuations increased for those who undervalued the instrument, with no effect on those who overvalued it, resulting in a pure welfare gain.
• Deliberative Competence:
  • The paper proposes using the sum of the absolute value or the square of the moneymetric bias as a measure of "deliberative competence."
  • This measure can be rationalized as the dollar-equivalent welfare loss a consumer suffers due to "characterization failure" (failing to understand the problem).
  • According to this measure, the intervention unambiguously improves the quality of financial decision-making only if it includes practice and feedback.
• Lessons:
  • It is not enough to find that financial education affects financial literacy and behavior in desired directions.
  • It is essential to investigate the reasons for those effects.
  • It is not enough to focus on average treatment effects; one must consider the heterogeneity of biases and treatment effects.
  • It is not enough to focus on conventional outcome measures; one must use measures with welfare interpretations.

3. Can Improvements in Financial Knowledge Lead to Worse Financial Decisions?

• This section raises concerns about the assumption that improving financial knowledge necessarily leads to better decisions.
• Bernheim introduces the concept of the "uncanny valley" as a cautionary tale, suggesting that the relationship between financial knowledge and decision quality may not be monotonic.
• He proposes a theory that self-assessed competence may outstrip actual competence, leading to a decrease in "metacmpetence" (how good one is at assessing their own competence).
• Individuals with high self-assessed competence may be less likely to seek advice from others, potentially leading to lower-quality decisions.
• Bernheim also expresses concern that increased knowledge of complex financial instruments like options and derivatives may lead to misuse and damaging mistakes.
• Lessons:
  • Financial education programs should give people a feel for the scope of what they don't know.
  • Educating people about available aid and assistance may be as important as improving their financial literacy.
  • When assessing financial education programs, it may be important to evaluate effects on metacmpetence separately from effects on competence.

4. How Does Poor Financial Knowledge Interact with Other Biases?

• This section discusses the interaction between poor financial knowledge and other behavioral biases.
• Correcting one source of poor decision-making without addressing others may be counterproductive.
• Bernheim uses the example of individuals with unreasonably optimistic expectations about investment returns who are also present-biased.
• He discusses different approaches to policy compartmentalization:
  • Comprehensive Second Best Analysis: Analyzing all distortions and remedies simultaneously (Lipsey and Lancaster).
  • Narrow Second Best Welfare Analysis: Evaluating one policy targeting one distortion while accounting for all other distortions (Meade).
  • Myopic Welfare Analysis: Analyzing a small number of biases and associated policies while assuming that the consumer's decision-making apparatus is otherwise perfect.
  • Idealized Welfare Analysis: Evaluating policies designed to address a single bias under the assumption that effective remedies for other biases will be forthcoming.
• The paper proposes idealized welfare analysis as a way to avoid the Lipsey-Lancaster critique of myopic welfare analysis.
• Under a relatively weak separability condition, the deliberative competence metric calculated myopically approximates the idealized welfare effect up to an unknown multiplicative scaler.
• Lessons:
  • When evaluating financial education policies, it is essential to explain the position one is taking concerning other biases that may impact decisions.
  • In settings where other biases are suspected, it is important to either take those biases into account or to use evaluation methods that are robust with respect to their potential existence.

5. Does Financial Education Involve Unconventional Costs and Benefits?

• This section explores the non-instrumental costs and benefits of financial education.
• Knowledge and beliefs may have non-instrumental costs and benefits, as reflected in adages like "Give me truth" and "Where ignorance is bliss, 'tis folly to be wise."
• Bernheim discusses the case of individuals who avoid financial decision-making because they find it stressful.
• He raises the question of whether people prefer not to live a lie, referencing Robert Nozick's experience machine thought experiment.
• He connects this to policy questions in economics, such as tax salience.
• Bernheim notes that financial education aims to get people to have correct beliefs, and the issue is whether the correctness of their beliefs matters intrinsically.
• He discusses the non-comparability problem in behavioral welfare economics, which arises because changing the locus of decision-making from the planner to the individual can change the decision problem.
• He suggests using hypothetical choices or surrogate choices to address this problem.
• Bernheim presents pilot results from a hypothetical choice experiment in which individuals are asked whether they would want to learn the truth about a furniture shop owner, even if the information cannot be helpful for any future decision.
• The results show that some individuals strictly prefer to learn the truth, while others prefer to remain ignorant.

6. Conclusion

• Bernheim concludes by emphasizing that research on financial education should focus on normative questions about whether these policies are making people better off, rather than just on positive questions about what happens to choice and financial literacy.
• This focus requires grappling with conceptually difficult questions, but there are solutions and directions that can be taken.

7. Additional Advice for Students

• Never agree to be chair, especially during an epidemic.
• Sniff out what is not being answered in the literature.
• Jot down ideas while reading papers and attending seminars.
• Start the research process without reading all of the literature to avoid being hardwired into existing ways of thinking.
• Have both safe projects (N+1 extensions) and projects where you're swinging for the fences.
• When dealing with referees, get them on your side and translate their comments into improved exposition.
• Write kinder referee reports than you receive.
• Position your paper in a way that will connect with a broad audience.