A living lab for studying expectations

How will the grant awarded to the project enable you to reach your goals?

The Sapere Aude programme will allow me to establish an international network of world leading economists with diverse expertise, providing key contributions to the emerging field of behavioural macroeconomics. The programme will allow to lay the foundations for a long-term “living lab” for studying the role of expectations for the economy.

What is this project about?

The most important decisions in our life often depend on our expectations of the future. If you want to buy a house, you need to decide how much debt you can afford, which depends on your expectations about your future income and about the cost of debt, the interest rate.

And the impact of new policies also depends on people’s expectations. The Feriepenge/holiday pay was paid during and after COVID to stimulate the economy. But if people are pessimistic about the future, they will put the money to sleep in their bank account, and the policy will be less effective.

So to study our economy we need to ask: how do people form expectations and how do we model that process? The traditional approach in economics is to assume that people have rational expectations, meaning that people can always properly use all the information available to them to predict the future.

However, thanks to recent discoveries in behavioural science we now know that people often misuse or ignore information and often make systematic mistakes. This distinction is important, because if people can use all information to make accurate predictions about the future, they will generally make good decisions, and new policies will work as intended. But if people are systematically overconfident or systematically ignore some information (we all prefer good news over bad news!), then they will make systematic mistakes, and they will be systematically unprepared when a negative shock hits.

To understand when, why and how people have rational expectations or biased expectations we need three key ingredients that this project will deliver: first, we need to measure over time and at a large-scale people’s expectations about the future. Second, we need to be able to observe the difference between expectations and realised future outcomes. Third, we need to quantify how information causally affects expectations and behaviour.

Why is this project important?

We hope that this project will become the first living lab for systematically studying people’s expectations of the future. This is important to understand how better policies can be shaped and take peoples’ expectations into account and as a result become more effective.

For example, there is a lot of attention in Denmark on equal opportunities. But despite this equality, some individuals are better equipped to convert input into output. One factor that could reduce the equalising role of public policy is citizens’ expectations: Citizen’s life experience and socioeconomic environment may to a very large extent affect their expectations about how they can influence their own outcomes, preventing some from seizing opportunities and reaching full potential. This project will provide much needed evidence of the role expectations play in relation to the economy, and it will potentially uncover important differences in expectations and information processing, which would inform future designs for smarter policies.

What are the challenges and perspectives?

Understanding how people form expectations, and how their memory contributes to this process has fundamental consequences for the way we design our policies and study our economy. If we can connect large survey data with register data, we will shed light on how people’s lives systematically affect the way they form expectations, and how expectations affect their decisions. We will need a large representative sample of the population for this exercise to be highly informative for policy, and our hope is that many Danes will see the importance of participating and contributing to this type of research.

What do you expect results to be?

Our goal is to answer important questions for economics and public policy. For example: Are people’s expectations systematically influenced by their past outcomes? And are people systematically over-optimistic in their expectations about their personal future? Do people underestimate the variability of future shocks that may happen to them? Are people attentive to information about new policies, and how does information affect people’s decisions?
 

Read more about Assistant Professor Luigi Butera here

Read more about the project here