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How Much Did Americans' Financial Illiteracy Contribute to the Great Recession?

We’re working on a new Freakonomics Radio podcast about financial illiteracy, a topic we’ve visited a few times on this blog. Two guests you’ll hear from in the episode have held the same title: chairman of the White House Council of Economic Advisors.

First up is current chairman Alan Krueger, whom I asked what would improve if Americans were more financially literate:

KRUEGER: I think first and foremost, we’d probably have greater savings. People are often in a situation where they have to live paycheck to paycheck. That’s something I think we need as a country to work to improve. Most importantly I think we can improve income growth for the broad middle class. But many people who seem to have the wherewithal to save for the future find it difficult to save. So for example, they don’t take advantage of some of the tax benefits of some of the savings plans, which is really unfortunate because they’re leaving money on the table. And when it comes time to retirement, or when it comes time to needing those savings, they have a very thin cushion. So I think the biggest difference would be if we can improve financial literacy and if as a result people act based on their own personal interest to a greater extent, I think we would see higher savings, which would in the long run translate to greater investment and probably higher income growth for the country.

You’ll also hear from Krueger’s predecessor in the job, Austan Goolsbee, who’s now back at the University of Chicago. I asked Goolsbee how big a problem financial illiteracy really is. I was surprised to hear him list it as a major contributing factor to the Great Recession:

GOOLSBEE: I think it’s pretty important at most times, but as we saw in this last financial crisis it can become unbelievably important. So just for your own sake, you know, your own retirement, or your own making sure that you can send your kid to college and this sort of thing, you’ve got to at least know the basics of how to save money — if you’re going to invest the money, where are you putting it, that you’re not taking crazy risks that you don’t understand, and things like that. But then, you know, we saw through the 2000s as we in some ways ripped up the rules of the road and took away some of the restrictions that financial institutions had in offering financial products to consumers, there were a lot of people with limited financial literacy who got into extremely complicated mortgages. And those mortgages blew up, and that the magnification of those explosions essentially caused the financial crisis and the worst recession of most any of our lifetimes.

Keep an ear out for the entire episode, in a week or so.