What Behavioural Economics Has to Say about Financial Literacy

Abstract

Gaps in financial literacy are arguably responsible for significant errors in decision-making

by consumers and investors alike. Unlike the conventional neoclassical economic wisdom,

behavioral economics opens the analytical door to the significance of financial literacy for

decision-making. This paper presents evidence on the importance of financial literacy as well

presenting the different analytical approaches to financial literacy that flow from neoclassical

economics and from the different methodological approaches to behavioral economics.

Of particular importance is the errors and biases approach, which attributes much of

financial illiteracy to the cognitive shortcomings of the human brain. Whereas the bounded

rationality approach focuses on informational gaps (complex and asymmetric information),

framing effects, institutional design problems, and human capital deficits (inclusive of

experiential learning), as key to understanding documented gaps in financial literacy.

The behavioral approaches have significant implications for analyses and public policy.