Personal finances and the Covid-19 crisis
Text: Francisco Pitthan and Kristof De Witte, Leuven Economics of Education Research, KU Leuven
A popular Danish saying among economists says “it is difficult to make predictions, especially about the future”. But the truth is that people make predictions all the time. For example, we make predictions about what is the best destination for our next vacation, or how much we need to save for retirement.
Sometimes our beliefs about the future are slightly updated due to small changes in our lives (e.g. a sprained ankle will make you postpone the hiking trip to the Ardennes) or drastic changes causing bigger updates (e.g., a big promotion or a job loss will make you review all your finances and spending patterns). But all of a sudden, a disease no-one was expecting turned upside down our daily lives, and with that our consumption habits and personal finances. Behavioural economics can be a great tool to help us understanding how people are facing the current Covid-19 crisis and how we should adapt ourselves in the aftermath of the pandemic.
How to cope with reduced income?
Among the effects of the current crisis, many Belgians are facing important income reductions, due to total or temporary unemployment (with 30% of wage reduction), or due to lower demand of commercial activities (or even the suspension of business to respect the law), in the case of small-business owners and self-employed people. This income reduction makes it hard for people to maintain the same quality of life they had before, either making them reduce their consumption expenditures or forcing them to seek loans and use their emergency savings. A possible solution for this is an insurance against income losses (see also the portal www.gonna.be that has been developed by Baloise Insurance and KU Leuven).
In addition to the direct effects in our behaviour due to social distancing and income, our habits are changing due to behavioural and psychological effects. It is only natural that many of us might be experiencing fear and anxiety with the global pandemic that we face. But those feelings can be a double-edged sword, in the same way fear can help us to choose the best possible action when we feel prepared to face a threat, it can also trigger our defence-mechanisms when we feel helpless, making us seek for our most basic needs (food, shelter, essential utilities). Those feelings help us to explain the panic shopping spree that we observe in Belgium, with many families running to stock food and supplies for quarantine, such as eggs and toilet paper.
In the other extreme, we observe the case of people with over optimistic bias, which can be useful to reduce the effect of negative emotions, but can wrongly lead people to minimize the effects of the disease or the change of infection, one example being the many lockdown parties which still happen in our country.
Other people influence our behaviour
Not only psychology and emotions can impact our actions, we are also influenced by others. Our behaviour is shaped by social norms, by our perception of what most people in society do, approve and dislike. However, those perceptions are often wrong or biased. By having friends in lockdown parties or members of the same community in panic shopping, for the fear of missing out and for believing those actions are normal, people often imitate their peers, making us observe herd-behaviour. This resulted herd-behaviour can also be positive, seeing most people in the community taking the necessary protective measure against the disease make us compelled to do the same. The degree of our influence is also noted by our emotions, our proximity and trust. The direction of our emotions (negative or positive) make us retain and pay attention more to different types of news (e.g. positive new if we are feeling positive). The recurrent feeling of unfamiliarity and cluelessness for facing a new threat makes it easier to follow the behaviour and advice of people close to us and of people we trust, especially in the short-run. As we gain more knowledge and experience, in the medium and long-run we will adapt our behaviour, only continuing to imitate actions we identify as good and efficient, sometimes replacing them for better actions that we did not think in the beginning.
The Corona crisis also impacts how everyone faces their personal finances, with an income effect and a preference effect. First, the income effect can be different depending on our occupational situation during the crisis. For people with the same salary but lower expenses, the increase in disposable income makes people increase their demand for financial protection, such as in investments, savings, retirement funds and insurance plans. On the other hand, people with a decrease in disposable income are now looking more for personal finance information, since they are now re-planning their current and future expenses, savings and investments. The second effect comes from our preferences, with the Corona crisis we are becoming more conscious about the future risks we face, both related to our health and future income shocks. For this, many people are looking for more and better ways of protection, which shall increase demand for many insurance and financial products. The current uncertainty also increases the preferences for more liquid and less risky assets, which have less variation to external factors and that could be easily retreated in cases of emergencies. Therefore, KU Leuven has developed with Baloise Insurance the platform www.gonna.be to check for your personal finances.
Our minds can change our behaviour
Many people are already worried with the aftermath of the current crisis, which is comprehensible, we all want our lives back to normal. Many businesses and sectors of the economy are facing a repressed demand, which shall receive a huge initial boost when things go back to normal. We can learn from earlier experiences abroad. Facing the SARS disease in 2003, people in Taiwan were afraid of going to hospitals since many of the infection were happening in that environment. Even 4 months after the crisis the demand for hospitals was still low, in some communities decreasing between 30% and 40%, which can be explained by the herd-behaviour, of people imitating the actions of their peers. This can have a parallel here in Belgium for the case of both hospitals and nursing homes, which can experience this lower demand even after the lockdown. Canada (which also faced the SARS crisis in 2003), found that promoting a big music festival with the Rolling Stones in Toronto could motivate people to go back to tourism, economic and social life.
Our minds can change our behaviour, which is the way our brain uses to face adversity, uncertainty and lack of knowledge. Although those changes can be useful in the short-run for protection, they can have dreadful effects to our personal and financial well-being. Fear and anxiety may lead us to make hasty decisions, but we need to bear in mind that life-changing decisions with long lasting consequences still need to be taken carefully, with plenty of study. This also includes our financial decisions, the lack of action or the bad choices made now can have effects in all of our life.
Authors would like to thank the funding from Baloise Insurance Research Chair of Financial Well-Being.