Financial Stress, Decision Bias, and the Well-being of Low Income Older Households

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Financial Stress, Decision Bias, and the Well-being of Low Income Older Households This project will investigate whether financial stress affects decision-making. Recent work in psychology and economics argues that resource scarcity changes how people look at problems and make decisions (e.g., Shah et al. 2012), which could explain why the poor often engage in behaviors that reinforce their conditions of poverty. Such psychology of poverty may underlie the SES-health gradient if it leads the poor to make bad health decisions. More importantly, it would imply a self-reinforcing cycle of poor health and poverty. Individuals in poor health, who have lower productivity and lower wages, are more likely to be financially stressed, which in turn would lead them to make bad economic and health decisions—worsening their health and their economic circumstances. Poor decision-making may also put financial security in old age at risk. However, it is empirically challenging to test whether financial stress affects decision-making. First, the relationship may go in the opposite direction: Decision-making may affect the chances of one experiencing financial stress. The relationship may also be confounded by unobserved third factors such as cognitive ability. We propose to study the causal effect of financial stress on decision-making by exploiting the sharp discontinuity in liquidity at payday. Previous work has shown that the expenditures and the caloric intake of Social Security and Food Stamp recipients increase sharply at payday. This pattern is observed only for households with little savings, indicating households experience increased financial stress right before payday. To exploit the discontinuity at payday, we will collect data using a unique survey design in which participants are randomly selected to be surveyed before payday (i.e., treatment) or after payday (i.e., control). We will use an Internet-based longitudinal survey with 5,000+ respondents, the RAND-USC American Life Panel (ALP), which allows us to manipulate the date at which each respondent is interviewed. We will investigate whether the treatment group is more likely to exhibit decision-making biases—such as the use of heuristics, present bias, narrow bracketing, and framing effects—than the control group. The randomization implies that any differences in the measured decision-making of the two groups can be attributed to the effect of being surveyed before or after payday. Results from a pilot study show a discontinuous change in expenditures at payday, indicating the study design is successful in capturing changes in financial stress. The current project would make several contributions. First, to the best of our knowledge, this study would be the first study to examine whether financial stress causally affects decision-making. Second, by providing direct evidences on whether there is a causal link between financial stress and decision-making, this research will contribute to our understanding of heterogeneity in choices. Finally, the results will also be of interest to policymakers. If financial stress has a causal effect on decision-making, it would indicate the importance of social programs that could break a perverse and self-reinforcing cycle of poor health and poverty.