Psychology, decision-making and personal finance are intertwined. That’s not news to anyone who has ever agonized over a budget, but a group of behavioral science researchers has come up with some new insights into ways in which the federal government might put these connections to good use.
In a paper published in Behavioral Science & Policy, Harvard Kennedy School professor Brigitte Madrian and a cadre of co-authors analyze three psychological tendencies that commonly affect consumer welfare. They call on the federal government, in its dual role as employer and regulator, to implement a series of innovations to make personal financial decisions clearer and simpler for all Americans.
The authors explore three psychological tendencies that trip up consumers who want to handle their money responsibly, but sometimes struggle to do so. The tendencies are imperfect optimization (incorrectly calculating the benefits and trade-offs of various financial options); biased judgments and preferences (giving undue weight to certain factors other than financial benefit); and sensitivity to social context (letting others’ decisions affect their own, to their detriment). In each case, the authors argue, these tendencies can complicate financial decisions that already appear daunting or complex.
The authors urge the federal government to try out interventions that can limit financial mistakes and improve consumer welfare. “As the nation’s largest employer, the federal government is well positioned to help its employees improve their financial health and serve as a model for other employers,” they argue.
Some of the authors’ suggestions include simplifying the retirement savings process for employees who have the option to participate in 401 (k) or Roth savings plans. The authors also suggest helping individuals and families gain a better understanding of how to save their tax refunds, and providing more information about withholding allowances on W-4 forms and how to apply for financial aid for higher education.
In each situation—whether it’s saving for retirement, investing a tax return, managing personal debt or applying for student loans—Madrian and her co-authors call for clarity, simplicity and more information. They argue that more and better information will help anyone struggling to make smart financial decisions, either on their own or with the help of the U.S. government.