A Service of

Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics

Kuhnen, Camelia M.

Article Household expectations: From neuroscience to household finance and macroeconomics

NBER Reporter

Provided in Cooperation with: National Bureau of Economic Research (NBER), Cambridge, Mass.

Suggested Citation: Kuhnen, Camelia M. (2019) : Household expectations: From neuroscience to household finance and macroeconomics, NBER Reporter, National Bureau of Economic Research (NBER), Cambridge, MA, Iss. 4, pp. 20-22

This Version is available at: http://hdl.handle.net/10419/219448

Standard-Nutzungsbedingungen: Terms of use:

Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes.

Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu Household Expectations: channel. That is, about 20 tures information about to 30 percent of the effect Macroeconomic Optimism by Income Level the mean outcome that of income or education each respondent expects, From Neuroscience to Household Finance and Macroeconomics 0.9 on choices such as invest- as well as the uncertainty ing in equities or buying Top income quintile associated with that Camelia M. Kuhnen a home is driven by the 0.6 expectation. We find that fact that higher-SES indi- individuals with lower viduals are more optimis- 0.3 income and education Recent work in neuroscience and neuroeco- tus (SES), form more pessimistic beliefs about tic about macroeconomic levels, facing more precar-

nomics has provided valuable insights into the fac- financial investments and economic opportuni- conditions. The aggregate 0.0 ious financial conditions tors that drive individuals’ formation of expecta- ties and avoid investing in stocks or real estate. implication of this find- or living in counties with tions. These insights can be used by economists to Controlling for participants’ prior beliefs and the ing is that pessimistic mac- higher unemployment, better understand individuals’ beliefs and behav- information they possess regarding investment roeconomic expectations -0.3 report more uncertainty iors. Moreover, aggregate-level implications can options, Miu and I find that lower-SES indi- held by lower-SES indi- Bottom income quintile about their expectations. be drawn from these micro-level findings. viduals update less from high asset payoffs than viduals are part of the rea- −0.6 Drawing on objec- Neuroscientist Brian Knutson and I docu- their higher-SES counterparts, and end up with son these individuals stay 1980 1985 1990 1995 2000 2005 2010 2015 tive measures of uncer- mented an asymmetry in the brain in the pro- more pessimistic beliefs about the quality of these away from risky financial tainty derived from the 1 Shaded regions are NBER-dated recessions cessing of gain and loss information. This dis- assets. As a result, lower-SES individuals are less investments and as a result Source: Das S., Kuhnen C. M., Nagel S., NBER Working Paper 24045 volatility of aggregate covery of asymmetric encoding of positive and likely to invest in these assets, particularly at times accumulate low levels of inflation and national negative outcomes led to a hypothesis that could when, objectively, the assets can be expected to wealth, whereas higher- Figure 1 home price growth, we be tested experimentally in the context of finan- have high payoffs.4 SES individuals hold opti- find that lower-SES indi- Camelia Kuhnen is a cial decision-making. In experiments conducted While lab experiments allow researchers to mistic beliefs and make investments with high macro-level economic expectations, and, all viduals report distributions of expectations professor of finance at the in three countries — the United States, Romania, test hypotheses in controlled environments, there expected returns. Over time, this may lead to else being equal, more uncertain individuals that are more diffuse — “wider” — than the Kenan-Flagler Business and Germany — I have found that learning occurs is always a question about the external valid- an increase in wealth inequality. It remains to engage in more cautious behaviors.7 We use objective distributions. Furthermore, we find School at the University of differently depending on whether gain or loss has ity of lab findings. To investigate whether it is be seen whether the same patterns of differ- data from the Federal Reserve Bank of New that if a person reports more uncertainty North Carolina at Chapel taken place. Specifically, negative outcomes induce generally true that those with lower incomes or ential expectations by SES level, as well as dif- York Survey of Consumer Expectations about one of the three economic variables in Hill. She is an NBER research overly pessimistic beliefs about investment pay- lower education have overly pessimistic beliefs ferential levels of investment because of these (SCE) covering more than 1,200 households the survey, they are also more likely to report associate affiliated with offs.2 This is because, in an environment charac- about financial investment opportunities, as well expectations, also affect investments in edu- each month, 2013 to 2017. Respondents more uncertainty for the other two vari- the Asset Pricing Program, terized by negative payoffs, people put too much as about macroeconomic conditions in general, cation or human capital, or the decision to report their expectations about three vari- ables. This effect, the extrapolation of uncer- and an associate editor at weight on each additional bit of bad news. This Das, Nagel, and I use data from the University engage in entrepreneurial pursuits. ables: their personal income growth, the tainty across domains, is particularly strong The Journal of Finance, The experimental finding suggests that, at the aggre- of Michigan’s Surveys of Consumers (MSC). Adversity does not just impact the lens national inflation rate, and the rate of growth among low-SES individuals. [See Figure 2.] Review of Financial Studies, gate level, recessions could last longer and be more We use monthly data over 38 years with about through which individuals view economic of national home prices over the upcoming We also find that uncertainty in economic Management Science, and severe than predicted by standard models, in part 180,000 person-month observations. The data opportunities in a glass half-full versus glass 12 months. The elicitation procedure cap- expectations influences behavior in ways con- The Review of Corporate because of undue pessimism among individuals. include SES measures (i.e., income rank in half-empty manner. It sistent with prior theo- Finance Studies. She is a past Participants in my experiments were tem- the respondent’s age bracket, as well as educa- also impacts perceived Pairwise Correlation of Uncertainty in Expectations of Economic Variables ries: All else equal, those president of the Society for porarily exposed to environments characterized tion), five macro-expectations measures, includ- uncertainty about the with higher uncertainty

Neuroeconomics. by only positive or only negative payoffs; they ing beliefs about future stock market returns or economic environment. 1.0 regarding economic out- Kuhnen’s research spans exhibited a clear bias toward pessimism in learn- the national unemployment rate, as well as self- This idea comes from comes are more likely to neuroeconomics, household ing in the loss domain. Outside of the laboratory, reported household choices such as equity invest- work in cognitive science engage in precaution- 0.8 Correlation of personal finance, and empirical corpo- however, many people have encountered nega- ments or the purchase of homes, durables, or and neuroscience that income and house prices ary behaviors in terms of rate finance, with an empha- tive outcomes on a regular basis, experiencing sig- cars. The large- scale evidence we find using the shows that life adversity, Inflation and house prices consumption, credit, and sis on labor and person- nificant adversity. Do they process information MSC is consistent with the experimental find- which is characterized by 0.6 investment decisions, in nel issues. She has BS degrees about economic outcomes differently than oth- ings. Namely, we find that higher-SES individu- environmental instabil- that they plan to lower in finance and in neurosci- ers in the same age cohort, with the same mac- als are more optimistic about the macro-econ- ity, influences learning. 0.4 their consumption, seek

ence from MIT and a PhD roeconomic history? Neuroscience suggests that omy relative to lower-SES individuals, but that in Specifically, individuals Inflation and personal income additional lines of credit, in finance from Stanford to be the case. Specifically, it has been shown that recessions, this expectations gap narrows dramat- faced with adversity per- 0.2 and invest less in equities. University. Prior to join- experiencing adversity shapes the way the brain ically.5 [Figure 1 on the following page.] ceive that the overall envi- Our findings sug- 6 ing the University of North learns, so that there is an increased neural sensitiv- While it has been known that SES measures ronment is volatile. 0 gest that it is important to Carolina at Chapel Hill, she ity to loss information and a decreased neural sen- like income and education matter for financial In a recent study, $5,000 15,000 25,000 35,000 45,000 55,000 67,500 82,500 125,000 175,000 200,000 understand which house- 3 was an associate professor sitivity to gain information. In recent research, choices — for example, households earning higher Elyas Fermand, Geng Li, Income holds are more uncer- of finance at Northwestern Sreyoshi Das, Stefan Nagel, Andrei Miu, and I incomes are more likely to participate in the stock Itzhak Ben-David, and I tain in their expectations, University’s Kellogg School find in laboratory experiments as well as in large market — using data from the MSC, we docu- find that lower-SES indi- Source: Fermand E., Kuhnen C. M., Li G., and Ben-David I., NBER Working Paper 25336 as this uncertainty can of Management. survey data that people who have encountered ment that part of the link between SES and house- viduals are more uncer- impact responses to policy more adversity, measured by socioeconomic sta- hold choices can be attributed to the expectations tain in their micro- and Figure 2 changes targeting expec-

20 NBER Reporter • No. 4, December 2019 NBER Reporter • No. 4, December 2019 21 tations and behavior. The 3 “Cumulative Stress fact that lower-SES indi- Self-Eicacy and Financial Delinquency in Childhood Is NBER News viduals and those from Associated with Financial delinquency rate communities with worse 20% Blunted Reward- economic conditions are Related Brain Activity Abhijit Banerjee, Esther Duflo, and Michael Kremer Awarded Nobel Prize the most uncertain sug- 18 in Adulthood,” gests that a reduction of 16 Hanson J, Albert Abhijit Banerjee and Esther uncertainty would have a Late debt D, Iselin A, Carré J, Duflo of MIT and Michael Kremer of higher impact on the deci- 14 Dodge K, Hariri A. Harvard University, all of whom are sions of these individuals Social Cognitive and long-time NBER research associates, than on the decisions of 12 Affective Neuroscience, were awarded the 2019 Nobel Prize Late bills those who are better off. 10 11(3), March 2016, pp. in Economic Sciences. The prize rec- Lastly, neuroscience 405–412. ognizes their contributions to devel- work has documented 8 Return to Text opment economics and the study of 1 2 3 4 5 4 heterogeneity regarding Approximate quintile of Pearlin score “Socioeconomic Status global poverty. In particular, it cites the brain’s response to (A higher quintile indicates a greater level of self-assessed self-eicacy) and Learning from their championing of randomized con- adversity. Specifically, self- Financial Information,” trolled trials and field experiments as Pearlin scores are from the year before financial delinquency status is assessed. Shading represents 95% confidence intervals. efficacy modulates the Source: Kuhnen, C. M., Melzer, B., NBER Working Paper 23028 Kuhnen C, Miu A. methodologies for analyzing how a ability to deal with nega- NBER Working Paper wide range of policy interventions — in From left, Abhijit Banerjee, Esther Duflo, and Michael Kremer 8 tive shocks. Self-efficacy Figure 3 21214, May 2015, and health, education, credit markets, and is a personal characteris- Journal of Financial local governance, among others — can tic that captures the strength of an individ- is that non-cognitive skills, including having Economics 124(2), May 2017, pp. 349–372. contribute to poverty alleviation. experiments among the people who are most affected.” ual’s belief that his or her actions can influ- positive expectations about one’s ability to Return to Text The laureates’ work has“ considerably improved our ability The full announcement of the Nobel Prize award may be ence the future. Using data from the National influence one’s future, can shape the financial 5 “Socioeconomic Status and Macro­ to fight global poverty. In just two decades, their new, experi- found here; the Royal Swedish Academy also provided a lon- Longitudinal Survey of Youth Child and health of populations. Such expectations are economic Expectations,” Das S, Kuhnen ment-based approach has transformed development econom- ger explanation of the scientific contributions that underlie Young Adult sample (NLSY79CYA) of particularly beneficial for individuals coming C, Nagel S. NBER Working Paper 24045, ics,” the Royal Swedish Academy of Sciences said in a state- this work. about 6,000 individuals tracked from their from lower-SES backgrounds, where tradi- November 2017, and forthcoming in ment announcing the award. A key element of the researchers’ On December 8, 2019, the laureates delivered lectures in teens to adulthood, for whom we have tional financial products or intrafamily insur- Review of Financial Studies. strategy is a focus on questions that concern specific contribu- Stockholm on the subject of their prize-winning work. Banerjee detailed financial information in 2010, 2012, ance may not be available to cushion the Return to Text tors to poverty, such as lack of education or poor health. Their and Duflo each lectured on “Field Experiments and the and 2014, as well as measures of self-efficacy effects of negative economic shocks. 6 “Rational Snacking: Young Children’s central methodological contribution is the recognition that Practice of Economics;” Kremer lectured on “Experimentation, earlier in life, Brian Melzer and I find that We still have a lot to learn about why Decision-making on the Marshmallow these questions “are often best answered via carefully designed Innovation, and Economics.” people who have high self-efficacy scores are households differ in their expectations Task is Moderated by Beliefs about more likely later on to avoid being financially about economic variables that can influ- Environmental Reliability,” Kidd C, Palmeri Banerjee’s lecture Duflo’s lecture Kremer’s lecture delinquent, in the sense of missing debt pay- ence their consumption or wealth down the H, Aslin R. Cognition, 126(1), January ments or bill payments, especially when hit road. The data we have so far indicate that 2013, pp. 109–114. by shocks such as a health issue or the loss of a these expectations are predictable to some Return to Text Banerjee is the Ford Foundation International Professor With this year’s awards, 32 current or past NBER job.9 [See Figure 3.] As a result, lower self-effi- degree, and that a lot of these predictions 7 “Expectations Uncertainty and Household ofEconomics at MIT and a co-director of the Adbul Latif research affiliates have received the Nobel Prize: William cacy individuals are more likely to lose access can be informed by work done in other aca- Economic Behavior,” Fermand E, Kuhnen Jameel Poverty Action Lab (J-PAL). He is a research associ- Nordhaus and Paul Romer, 2018; Richard Thaler, 2017; to traditional credit markets and to lose assets demic disciplines, such as neuroscience and C, Li G, Ben-David I. NBER Working ate in the NBER programs on Development Economics and Oliver Hart and Bengt Holmström, 2016; Angus Deaton, through bankruptcy and foreclosures. Those psychology. Household expectations affect Paper 25336, December 2018. Economic Fluctuations and Growth. 2015; Lars Hansen and Robert Shiller, 2013; Alvin Roth, with higher self-efficacy put in more effort to many household economic decisions, and Return to Text NBER papers by Abhijit Banerjee 2012; Thomas Sargent and Christopher Sims, 2011; Peter protect themselves against potential shocks, are critically important determinants of the 8 “Affective State and Locus of Control Diamond, 2010; Paul Krugman, 2008; Edward C. Prescott for example, through insurance or emergency impact of various public policies. Further Modulate the Neural Response to Threat,” Duflo is the Abdul Latif Jameel Professor of Poverty and Finn Kydland, 2004; Robert F. Engle, 2003; Joseph E. savings, and when negative shocks occur, they investigation is needed to understand both Harnett N, Wheelock M, Wood K, Ladnier Alleviation and Development Economics at MIT and a co-direc- Stiglitz, 2001; James J. Heckman and Daniel L. McFadden, have a lower chance of experiencing financial their drivers and their consequences. J, Mrug S, Knight D. Neuroimage 121, tor of JPAL. She is a research associate in four NBER programs: 2000; Robert C. Merton and Myron S. Scholes, 1997; distress. We find that the beneficial effect of November 2015, pp. 217–226. Economics of Aging, Children, Development Economics, and Robert E. Lucas, Jr., 1995; and the late Dale Mortensen, having high self-efficacy in terms of avoiding 1 “The Neural Basis of Financial Risk- Return to Text Education. 2010; Robert W. Fogel, 1993; Gary S. Becker, 1992; 9 financial distress is triple in size for individu- Taking,” Kuhnen C, Knutson B. Neuron, “Non-Cognitive Abilities and Financial NBER papers by Esther Duflo George J. Stigler, 1982; Theodore W. Schultz, 1979; Milton als who have faced economic adversity early 47(5), September 2005, pp. 763–770. Delinquency: The Role of Self-Efficacy in Friedman, 1976; and Simon Kuznets, 1971. in life, as measured by having a mother who Return to Text Avoiding Financial Distress,” Kuhnen C, Michael Kremer, the Gates Professor of Developing Societies In addition, six current or past members of the NBER was in the lowest third of the population in 2 “Asymmetric Learning from Financial Melzer B. NBER Working Paper 23028, at Harvard, is also a research associate in four NBER programs: Board of Directors have received the Nobel Prize: George Children, Development Economics, Economic Fluctuations wealth, relative to the effect observed among Information,” Kuhnen C. Journal of Finance, January 2017, and Journal of Finance, 73(6), Akerlof, 2001; Robert Solow, 1987; and the late William those whose mothers’ wealth was in the top 70(5), October 2015, pp. 2029–2062. December 2018, pp. 2837–2869. and Growth, and Education. Vickrey, 1996; Douglass North, 1993; James Tobin, 1981; third. The broad implication of these findings Return to Text Return to Text NBER papers by Michael Kremer and Paul Samuelson, 1970.

22 NBER Reporter • No. 4, December 2019 NBER Reporter • No. 4, December 2019 23