Recent findings in behavioral economics show that differences in perceptions can modify individual behavior in ways that have potentially relevant macroeconomic consequences. This is due to the presence of cognitive biases which lead individuals to make decisions that are inconsistent with the actual amount of available resources (Morewedge et al., 2007; Soman, 2001; Sussman and Shafir, 2012).
In line with these findings, the research intends to contribute to the literature on the causes of the recent financial crisis in the United States by adopting a different perspective with respect to the existing literature. To this purpose, it combines findings from behavioral economics and social cognitive psychology with the modern techniques of computational macroeconomics. In particular, the project introduces the construct of perceived wealth, which identifies a biased perception of individual net worth, whose value deviates from the actual value of wealth. By means of laboratory experiments, the research intends to investigate whether perceived wealth leads individuals to make non-optimal consumption and borrowing decisions that result in large household debt accumulation. Such empirical experiments also allow to identify a set of policies aimed at offsetting the cognitive bias behind the formation of perceived wealth, so as to nudge individuals into consumption and borrowing decisions that are consistent with their own resources, thereby limiting the consumption/debt euphoria.

Eventually, the researcher builds a full-scale stock-flow consistent macroeconomic agent based model in order to investigate how macroeconomic stability can be jeopardized when perceived wealth emerges for a large number of agents. Indeed, in this case, biased individual consumption and borrowing decisions become a potential source of instability for financial markets, since perceived wealth triggers a process of overconsumption and massive debt accumulation. In addition, in presence of the bias, individuals are also likely to overestimate their ability to pay back consumption loans in the future. This has substantial macroeconomic implications, as banks may accumulate non-performing loans that affect credit availability for future borrowers.

Hence, perceived wealth can determine consumption euphoria that eventually results in a debt crisis and a credit crunch.

Working group:

• Prof. Domenico Delli Gatti- Faculty of Economics
• Alberto Cardaci