Financial literacy, consumer education and economic outcomes
The U.S. Consumer Financial Protection Bureau (CFPB) was created in 2011 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new bureau is charged with overseeing everything from world-spanning banks like JP Morgan Chase, with its $2.39 trillion in assets, to humble payday lenders on neighborhood corners. In the aftermath of the real-estate crash, the CFPB is also on the front lines of policing debt collectors, foreclosure-related services, credit card providers and student loans.
A central challenge in protecting consumers is helping ensure that they have the knowledge they need to make fully informed decisions. A 2010 study by the Brookings Institution found that many of the traditional approaches, from credit counseling to school-based programs, appeared to have little influence on consumers’ behavior. Another 2010 study, from the University of Wisconsin, was less bleak: It determined that after a five-session financial-education program, the proportion of clients with credit scores less than 680 declined. The lack of financial knowledge appears to know few bounds: It’s widespread among the young, and many older workers report a high level of uncertainty about the amount of post-retirement income they’ll need.
A 2013 study for the National Bureau of Economic Research published in the Annual Review of Economics, “Financial Literacy, Financial Education and Economic Outcomes,” investigates the role that governments could play in helping consumers achieve better financial outcomes. The researchers — Justine S. Hastings of Brown University, Brigitte C. Madrian of the Harvard Kennedy School and William L. Skimmyhorn of West Point — analyze existing papers and studies on whether financial education improves financial literacy or personal financial outcomes.
The findings of the studies analyzed include:
- Correlations have been observed between financial literacy and consumers’ behavior and financial outcomes, but the causality is difficult to determine. “Most individuals cite personal experience as the most important source of their financial learning,” which suggests reverse causality — that experience creates literacy, not the other way around.
- Evidence of the effectiveness of financial education on increasing financial literacy is limited. “Financial Literacy of High School Students,” by Lewis Mandell of the State University of New York at Buffalo, found that there is “surprisingly little correlation between high school students’ financial knowledge levels and whether they have completed a financial education class.” Troublingly, “students from families with greater financial resources tend to be substantially more financially literate than those from families that are less well-off, thereby exacerbating the inequality of economic welfare among families.”
- The more basic the financial education, the better the results tend to be. “Keeping It Simple: Financial Literacy and Rules of Thumb,” by the Centre for Economic Policy Research in London, used two randomized trials to test the impact of financial training for microentrepreneurs in the Dominican Republic. Standard accounting training had little benefit, but a “simplified, rule-of-thumb training produced significant and economically meaningful improvements in business practices and outcomes.”
- Optimal levels of financial literacy exist for each individual, increasing with income, the discount factor and the return to financial literacy. “Aging and Strategic Learning: The Impact of Spousal Incentives on Financial Literacy,” by Joanne W. Hsu of the Federal Reserve Board, explored women’s financial knowledge. She found that women tend to have a lower average level of financial literacy than their husbands, but quickly gain in financial literacy with the prospect of impending widowhood. Thus limited financial knowledge may be acceptable in certain contexts.
- Research shows that firms have financial incentive to exploit consumers’ cognitive biases and limited financial literacy. According to “Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets,” a 2006 paper in MIT’s Quarterly Journal of Economics, these can include ostensibly low-priced financial services that have high hidden fees, or computer printers with low up-front costs but elevated per-page rates. Such crucial information is often intentionally “shrouded” — made difficult to find. This argues for increased consumer-protection efforts.
- When regulations require that price differentials be made explicit, consumers act on the information. “Advertising and Competition in Privatized Social Security: The Case of Mexico,” a 2013 paper for the National Bureau of Economic Research, found that when advertising is unregulated, consumers tend to focus on non-price attributes of goods; when costs are made explicit, consumers respond more to true costs.
“Although low levels of financial literacy acquisition may be individually rational in some models, limited financial knowledge may create [negative] externalities,” state the authors of the 2013 Annual Review of Economics paper. These can include higher prices for consumers, excessive use of social safety nets, reduced civic participation and negative effects on neighborhoods, families and children. “Such externalities may imply a role for government in facilitating improved financial decision making through financial education or other mechanisms.”
Keywords: consumer affairs
Read the issue-related New York Times article titled "Finance Class on the Web, for Students of All Ages."
- What key insights from the news article and the study in this lesson should reporters be aware of as they cover these issues?
Read the full study titled "Financial Literacy, Financial Education and Economic Outcomes.”
- What are the study's key technical terms? Which ones need to be put into language a lay audience can understand?
- Do the study’s authors put the research into context and show how they are advancing the state of knowledge about the subject? If so, what did the previous research indicate?
- What is the study’s research method? If there are statistical results, how did the scholars arrive at them?
- Evaluate the study's limitations. (For example, are there weaknesses in the study's data or research design?)
- How could the findings be misreported or misinterpreted by a reporter? In other words, what are the difficulties in conveying the data accurately? Give an example of a faulty headline or story lead.
Newswriting and digital reporting assignments
- Write a lead, headline or nut graph based on the study.
- Spend 60 minutes exploring the issue by accessing sources of information other than the study. Write a lead (or headline or nut graph) based on the study but informed by the new information. Does the new information significantly change what one would write based on the study alone?
- Compose two Twitter messages of 140 characters or fewer accurately conveying the study’s findings to a general audience. Make sure to use appropriate hashtags.
- Choose several key quotations from the study and show how they would be set up and used in a brief blog post.
- Map out the structure for a 60-second video segment about the study. What combination of study findings and visual aids could be used?
- Find pictures and graphics that might run with a story about the study. If appropriate, also find two related videos to embed in an online posting. Be sure to evaluate the credibility and appropriateness of any materials you would aggregate and repurpose.
Class discussion questions
- What is the study’s most important finding?
- Would members of the public intuitively understand the study’s findings? If not, what would be the most effective way to relate them?
- What kinds of knowledgeable sources you would interview to report the study in context?
- How could the study be “localized” and shown to have community implications?
- How might the study be explained through the stories of representative individuals? What kinds of people might a reporter feature to make such a story about the study come alive?
- What sorts of stories might be generated out of secondary information or ideas discussed in the study?