New Lessons from Behavioral Economics by Ulrike Malmendier and Clint Hamilton
Source details
- Canonical URL
- New Lessons from Behavioral Economics by Ulrike Malmendier and Clint Hamilton
Other formats
Bibliographic details
- Authors: ULRIKE MALMENDIER, CLINT HAMILTON
- Published: March 4, 2024
Overview
- Theme: The long reach of life experience affects real-world economic outcomes, for policymakers and consumers alike.
- Context: Uses the example of the Great Depression and “Depression babies” to illustrate how traumatic macroeconomic events alter beliefs and economic behavior across a lifetime.
- Key historical anchor dates and facts:
- October 29, 1929: “Black Tuesday,” US stock market collapse.
- Stock market did not match its 1929 peak until the 1950s.
- Only 13 percent of those who were teens and young adults during the Great Depression later invested in the stock market.
Behavioral beginnings
- Intellectual lineage:
- Late 1960s: economics dominated by mathematical models; psychologists Kahneman and Tversky begin collaboration.
- 1979: introduction of prospect theory.
- 2017: Richard Thaler awarded the Nobel Prize in economics for contributions that built on this work.
- Core insights from prospect theory and early behavioral economics:
- People overweight minuscule probabilities and underweight likely events.
- People care about changes in relative wealth and “wholeheartedly despise losses.”
- Behavioral economics initially identified anomalies and then, in the 2000s, documented empirical, real-world impacts and extended psychological insights into other fields (finance, labor, public, development, macro).
Mind and body: beyond flawed software metaphors
- Critique of prior metaphor: behavioral agents as computers with flawed “software” is insufficient.
- Neuroscience evidence:
- Neuroplasticity: the brain reorganizes pathways based on new experiences; frequently used pathways strengthen, unused pathways are pruned.
- Mechanism applied to Depression babies:
- Persistent effects from hunger, stress, and exposure to market failures rewired beliefs about financial markets and risk.
Experience effects — empirical patterns and domain specificity
- Definition: Personal lifetime experiences influence beliefs and decisions in a lasting way; people weight outcomes they have personally observed.
- Empirical patterns and examples:
- Investors who experienced lower stock market returns during preceding years are less likely to invest in the stock market; individuals with good experiences are more likely to invest.
- Generational weighting: a 60-year-old averages over many experiences; a 30-year-old gives larger relative weight to a recent crisis.
- Domain specificity: experiences affect decisions only within the same domain (stock-market experience does not affect bond-market investment).
- East vs. West Germany: those who lived under communism are much less likely to trust and invest in the stock market even years after reunification.
- Emotional valence matters: East Germans who had a fairly good life under communism are most adamant about harms of the stock market; those who suffered under the regime were more likely to embrace post-communism market economy.
- Unemployment experiences leave scars that affect consumer caution many years later.
- Bank behavior: banks with failing capital ratios respond with higher capitalization than others.
- Inflation:
- More than 50 years of survey data show the average inflation people have observed during their lifetimes strongly predicts their actual inflation expectations.
- Experience-based inflation expectations affect real decisions such as homeownership and mortgage choice (preference for homeownership and fixed-rate mortgages as inflation protection).
- Gender puzzle: women consistently had higher inflation expectations than men; resolved by noting that only in households where the woman was the primary grocery shopper did women have higher inflation expectations—food prices are salient and often face higher inflation or volatility.
Policymaker biases and examples
- Policymakers display experience effects in forecasting and decisions:
- Federal Reserve Board of Governors’ inflation forecasts tend to be biased toward their lifetime experienced inflation and away from expert analysts’ forecasts, reducing forecast accuracy.
- Example: Henry Wallich, raised during hyperinflation in 1920s Germany, dissented 27 times as a Federal Reserve governor because he emphasized concerns about inflation.
Four key features of experience effects
- The long-lasting effects of experience
- Greater weight on more recent events
- Domain-specific experience effects
- The negligible effect of learned knowledge vis-à-vis experience-based beliefs, however distorted
Policy implications and recommendations
- Speed and severity of crisis response:
- The long-lasting ramifications of experience effects increase the benefits of swiftly resolving crises; shorter and milder periods produce weaker long-term scarring, whereas traumatic experiences haunt people for years.
- Tailoring policies to heterogeneous lifetime exposures:
- Policymakers should account for different experiences across country-age-gender cohorts; the same intervention can yield vastly different responses depending on past exposures.
- Experience-based engagement over pure information campaigns:
- Direct engagement (e.g., pilot interventions) can change preferences more than theoretical explanations.
- Example: Affordable Care Act (ACA) in the United States — individuals who received direct, immediate benefits were more likely to support the ACA; initially skeptical Republicans who benefited directly were especially likely to become supporters.
- Pilot programs allow policymakers to test policies and build durable public support through positive personal experiences.
Podcast and authors
- Podcast: Ulrike Malmendier and Journalist Rhoda Metcalfe discuss how experiential learning rewires the brain and helps build better economic models.
- Authors:
- ULRIKE MALMENDIER: Cora Jane Flood Professor of Finance at the Haas School of Business; professor of economics at the University of California, Berkeley; member of the German Council of Economic Experts.
- CLINT HAMILTON: PhD student in finance at the Haas School of Business at the University of California, Berkeley.
Source: New Lessons from Behavioral Economics, F&D Magazine, ULRIKE MALMENDIER and CLINT HAMILTON, March 2024.
Content in this bundle
- New Lessons from Behavioral Economics