Working Paper: NBER ID: w25496
Authors: Francesco Dacunto; Daniel Hoang; Maritta Paloviita; Michael Weber
Abstract: Forecast errors for inflation decline monotonically with both verbal and quantitative IQ in a large and representative male population. Within individuals, inflation expectations and perceptions are autocorrelated only for men above the median by IQ (high-IQ men). High-IQ men's forecast revisions are consistent with the diagnostic-expectations framework, whereas anything goes for low-IQ men. Education levels, income, socioeconomic status, or financial constraints do not explain these results. Using ad-hoc tasks in a controlled environment, we investigate the channels behind these results. Low-IQ individuals' knowledge of the concept of inflation is low; they associate inflation with concrete goods and services instead of abstract economic concepts, and are less capable of forecasting mean-reverting processes. Differences in expectations formation by IQ feed into choice—only high-IQ men plan to spend more when expecting higher inflation as the consumer Euler equation prescribes. Our results have implications for heterogeneous-beliefs models of consumption, saving, and investment.
Keywords: Cognitive Abilities; Inflation Expectations; Economic Decision-Making
JEL Codes: D12; D84; D91; E21; E31; E52; E65
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Cognitive abilities (D91) | Inflation expectations (E31) |
| Cognitive abilities (D91) | Economic choices (P19) |
| Higher cognitive abilities (D87) | More accurate inflation expectations (E31) |
| Cognitive abilities (D91) | Understanding of inflation (E31) |
| Understanding of inflation (E31) | Inflation expectations (E31) |
| Cognitive abilities (D91) | Spending plans adjustment (H61) |
| High-IQ individuals (D29) | Adjust spending plans in line with inflation expectations (E31) |
| Low-IQ individuals (J79) | Associate inflation with concrete goods (E31) |
| High-IQ individuals (D29) | Positive correlation between past expectations and current perceptions of inflation (E31) |
| Low-IQ individuals (J79) | No correlation between past expectations and current perceptions of inflation (D84) |
| High-IQ individuals (D29) | Overreact to macroeconomic news (E32) |
| Low-IQ individuals (J79) | Mixed evidence of overreaction to macroeconomic news (E32) |