IQ, Expectations, and Choice
76 Pages Posted: 12 Sep 2019
Date Written: September 1, 2019
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: Behavioral Macroeconomics, Heterogeneous Beliefs, Limited Cognition, Expectations Formation, Household Finance
JEL Classification: D12, D84, D91, E21, E31, E32, E52, E65
Suggested Citation: Suggested Citation