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Financial Literacy Education: An Economist’s Perspective Alan B. Krueger Princeton University & NBER October 10, 2014 ExplorationsinEconomics.com Twitter: @Alan_Krueger Outline • Summary of Causes of Slow Recovery • Viewing the Great Recession and Modest Recovery Through the Lens of Lost Wealth • Connection to Financial and Economic Literacy -- Teaching Good Habits GDP Growth Has Not Kept Pace With Previous Recoveries Real GDP During Recoveries NBER-Defined Cycle Trough = 100 135 130 1982 125 Average 8 Recessions 120 1975 1991 115 2001 110 Current (2009:Q2 Trough) 105 100 95 90 85 80 -24 -16 -8 Trough 8 16 Number of Quarters Before or After Trough 24 Why is Economic Growth So Slow? • Consumption (69% of GDP in 2013) – Reaction to Lost Wealth, Job Loss and Economic Insecurity • Government Spending (19% of GDP in 2013) – Premature Austerity after Recovery Act. Private components of GDP growing as strongly as in 2001-07 recovery. • Home Construction (3% of GDP in 2013) – Housing bust following overbuilding in boom years Weak Recovery of Consumer Spending, Especially Services Real Consumer Spending During Recoveries NBER-Defined Cycle Trough = 100 135 Average 8 Recessions 130 125 1975 120 115 1991 1982 2001 110 Current (2009:Q2 Trough) 105 100 95 90 85 80 75 -24 -16 -8 Trough 8 16 24 Government Spending Became a Drag on the Economy, in Contrast with Previous Recoveries Real Federal Government Nondefense Purchases During Recoveries Real Federal Government Defense Purchases During Recoveries NBER-Defined Cycle Trough = 100 140 135 130 125 120 115 110 105 100 95 90 85 80 75 NBER-Defined Cycle Trough = 100 150 140 1982 130 2001 120 110 1975 Average 8 Recessions 100 1991 90 Current (2009:Q2 Trough) 80 70 -24 -16 -8 Trough 8 16 -24 24 -16 -8 Real State & Local Government Purchases During Recoveries NBER-Defined Cycle Trough = 100 130 125 1982 Average 8 Recessions 120 115 1991 110 1975 105 2001 100 95 Current (2009:Q2 Trough) 90 85 80 75 -24 -16 -8 Trough 8 16 24 Trough Average 8 Recessions 1975 1991 2001 1982 8 Current (2009:Q2 Trough) 16 24 Housing Bubble 250 1000 900 200 800 150 600 500 Home Prices 100 400 300 Building Costs Population 50 200 Interest Rates 0 1880 1900 1920 1940 1960 1980 2000 100 0 2020 Year Source: Robert Shiller. Home and building price indices are adjusted for inflation. Population in Millions Index or Interest Rate 700 Fall in Home Prices Led to Foreclosures, Financial Crisis and Housing Bust Working off the Excess Homes That Were Built Demand for New Residential & Mobile Home Units Thousands of Units, Annual Rate 2400 Apr-2007 2200 "Boom Years": 1996-2006 2000 1800 "Correction Years": 2007-2012 1600 Projected Annual Average Demand for New Units Based on Demographic Trends 1400 1200 1000 800 Apr-2014 600 400 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Cumulative Over- and Under-Building of New Residential & Mobile Home Units Since 1996 Thousands of Units, Annual Rate 3000 Apr-2007 Relative to Projected 2500 Annual Average Demand for New Units Based on 2000 Demographic Trends 1500 1000 500 0 "Boom Years": -500 1996-2006 -1000 "Correction Years": -1500 2007-2012 -2000 -2500 Apr-2014 -3000 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 • In the 1998 Economic Report of the President, the Council of Economic Advisers estimated that house construction would have to average 1.6 million units per year from 1996 through 2006 to keep pace with increased demand from population growth and household formation. • Residential construction substantially exceeded this level through 2006. As a result, overbuilding led to a cumulative excess supply of new housing that reached 2.6 million units in 2007. • Historically low levels of new construction since the implosion of the housing bubble allowed demand to catch up to the supply of new housing by 2011. In fact, there may have been some “overshooting,” with new housing supply below the pace needed to keep up with household formation. 9 Prices Rose and Home Construction Increased Once the Excess Supply was Worked Off Real Residential Investment During Recoveries NBER-Defined Cycle Trough = 100 240 220 200 Average 8 Recessions 180 160 1982 1975 1991 140 120 2001 100 Current (2009:Q2 Trough) 80 60 -24 September XX, 2014 -16 -8 Trough 8 16 24 10 Can Use to Teach Supply and Demand Excess Supply of Houses Leads Prices to Drop Decline in Home Building Leads Prices to Rise Understanding the Financial and Economic Crisis Through Wealth Destruction Household Net Worth Nominal Pre-Recession Peak = 100 125 120 115 110 Real Nominal 105 100 14:Q2 95 90 85 Average Real 80 Per Household 75 70 65 60 55 99:Q2 01:Q2 03:Q2 05:Q2 07:Q2 09:Q2 11:Q2 13:Q2 15:Q2 Note: Net worth adjusted for inflation using the personal consumption expenditures chain price index. Source: Federal Reserve Board; Bureau of Economic Analysis; Census Bureau. • • • • • $16 trillion of wealth was destroyed (1.5 years of disposable income) Drop in home prices and stock market drove wealth destruction Took 6+ years to rebuild lost wealth People feel poorer and consume less Low MPC households regained wealth sooner Household Net Worth Has Rebounded: Selected Assets trillion Source: Federal Reserve Board. Household Net Worth Has Rebounded: Selected Liabilities trillion Source: Federal Reserve Board. Connection to Economic and Financial Literacy Home Foreclosures and Delinquencies More Common Among Financially Illiterate Find this pattern controlling for age, gender, ethnicity, education, size of the household, time and risk preference parameters, labor market status over previous five years, the household’s income, and measures of income volatility. Source: Gerardi, Goette, Meier (2010). Widespread Economic Illiteracy PEW RESEARCH CENTER September 25-28, 2014 OMNIBUS Confused about Federal Finances As Well as Personal Finances PEW RESEARCH CENTER September 25-28, 2014 OMNIBUS U.S. 15-Year Olds Ranked 9th Out Of 18 Participating Countries on the 2012 PISA Financial Literacy Exam Financial Literacy Education: An Economist’s Perspective Alan B. Krueger Princeton University & NBER October 10, 2014 ExplorationsinEconomics.com Twitter: @Alan_Krueger • • • • • Behavioral Econ Habits of Mind Avoid Mistakes Choice Architecture Engage Students Keeping It Simple: Financial Literacy and Rules of Thumb By Alejandro Drexler, Greg Fischer and Antoinette Schoar American Economic Journal: Applied Economics, 6(2) 2014, pp. 1-31. Design of Experiment • 1,193 small business owners in Dominican Republic randomly assigned to 3 groups • Control group, standard accounting training course, rule-of-thumb training course • Accounting training taught basics of double entry accounting, working capital management, investment decisions, etc. • Rule-of-thumb training taught heuristics/routines without comprehensive explanation of accounting. For example: keep personal and business money in two separate draws, and only transfer with explicit IOU note, and count each drawer at end of month. “Overall, it appears that the micro-entrepreneurs in our study were more likely to implement what they learned in the rule-of-thumb training.” -- Drexler, et al. • Rule-of-thumb group had better improvement in financial practices, objective reporting, saving and revenue. • Greater gains for those in rule-of-thumb group who had lower skills or poor initial financial practices. Separate Personal and Business Cash 90% 80% 70% 60% 50% Control Acctng Rule-of-Thumb “INCREASING SAVING BEHAVIOR THROUGH AGE-PROGRESSED RENDERINGS OF THE FUTURE SELF” Hal Hershfield, Daniel Goldstein, William Sharpe, et al. Journal of Marketing Research, Nov. 2011. Actual Photo Avatar Aged Avatar Results • Participants who were exposed to their future selves in a virtual reality procedure allocated more than twice as much money toward their retirement account than did participants who were only exposed to their current selves; pvalue = .035. Financial Literacy Education: An Economist’s Perspective Alan B. Krueger Princeton University & NBER October 10, 2014 ExplorationsinEconomics.com Twitter: @Alan_Krueger