IQ, Expectations, and Choice

NBER Working Paper No. 25496

Issued in January 2019, Revised in September 2019

NBER Program(s):Economics of Aging, Asset Pricing, Corporate Finance, Economics of Education, Economic Fluctuations and Growth, Labor Studies, Monetary Economics



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.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w25496