Broadening the Scope of Financial Literacy to Incorporate Self-Control, Budgeting, and Heuristics

Abstract

Current measures of financial literacy focus on knowledge, and the literature on financial literacy has described important findings about the extent and impact of limited financial knowledge across the population. This paper discusses issues associated with broadening the scope of the financial literacy approach to include behaviors related to self-control, budgeting, and heuristics. Although the financial literacy literature models financial literacy as human capital in a neoclassical optimization framework, the discussion suggests that properly modeling this type of human capital cannot be easily accomplished through a neoclassical optimization model in which human capital is treated as a generic stock variable. Rather, budgetary human capital needs to be modeled explicitly as part of psychologically feasible heuristic processes that govern household behavior. In this respect, human capital involves more than fact-based knowledge and computational ability, but also mental processes that underlie action. Human capital pertains to both knowing and doing. Financial literacy in the form of knowledge can only produce better decisions when paired with human capital associated with acting on that knowledge.