Behaviorally Informed Financial Services Regulation, By Eldar Shafir, Michael Barr, Sendhil Mullainathan, New America Foundation, October 14, 2008
“Financial services decisions can have enormous consequences for household well-being. Households need a range of financial services-to conduct basic transactions, such as receiving their income, storing it, and paying bills; to save for emergency needs and long-term goals; to access credit; and to insure against life’s key risks. But the financial services system is exceedingly complicated and often not well-designed to optimize household behavior. In response to the complexity of our financial system, there has been a long-running debate about the appropriate role and form of regulation. Regulation is largely stuck in two competing models-disclosure, and usury or product restrictions. This paper explores a different approach, based on insights from behavioral economics on the one hand, and an understanding of industrial organization on the other. At the core of the analysis is the interaction between individual psychology and market competition. This is in contrast to the classic model, which relies on the interaction between rational choice and market competition. The introduction of richer psychology complicates the impact of competition. It helps us understand that firms compete based on how individuals will respond to products in the marketplace, and competitive outcomes may not always and in all contexts closely align with improved decisional choice and increased consumer welfare.”
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