Important topic, but strange to see an argument in favor of heuristics without mentioning Herb Simon, who amongst other things coined the term "attention economy" as early as 1971, at a time when computers just switched from punchcards to greenscreens. This would also change the angle on the outlook of behavioral economics, since the Carnegie tradition (Simon-Cyert-March) on cognitive limits works from a very different premise than the doomed Berkeley tradition (Akerlof-Kahneman-Rabin), namely decision making as a task at the intersection between economics and cognitive science.
There's that Felix Chopra paper from 2023 that shows that people reduce household expenditures by 5% when exposed to Ramsey. If we think Ramsay's audience's problem is that they need to be trained (through heuristics) to reduce their spending, then Ramsey is right.
All fine and good but heuristics have a cost too and at some point become not worth it. You most definitely should pay your high interest debt off first.
Not necessarily. For many, the risk isn't poor optimization or which debt to pay. The risk is giving up on the whole endeavor of reducing debt. Removing an entire bill reduces likelihood of giving up
Yes it's not rational. But Ramsey is not speaking to people who are already doing the obvious, rational things. His is a selected audience
I try to emphasize this as well when teaching behavioural econ: yes all these things - sunk cost bias, satisficing, recognition heuristic/availability heuristic - are irrational according to standard economic textbooks but they are also ways in which we deal with a world that's probably be a bit too complex for our human brain. There's loads of examples in the work of Gerd Gigerenzer. I often see him a bit as the anti-Tversky&Kahneman...
Nicely put. You graciously spared Dave Ramsey's of his actual errors, which involve overly constraining heuristics. Such as: never borrow to buy assets. I lost my bet as I was reading your post, however, as I was certain you'd cite Alchian's classic - from which you seem to borrow your ending flourish -- Uncertainty, Evolution, and Economic Theory (JPE 1950). (Did I miss it?) Your rendition did get me thinking about how the usefulness of rival systems (socialism v. capitalism, etc.) might be seen by compared how 'far up the stack' the reality constraints force rationalization of the imperfect decisions being made. With government expenditures, for example, low valued results might obtain over considerable activities for long periods, whereas with tight private household or firm budget constraints such resource squandering is expected to be mitigated in shorter order. This can be seen as an improvement in dealing with externality inefficiencies, a la Coase, yet another way to state the problem you deal with here.
Even economists maintain the taboo against speaking plainly about how life differs at below average cognitive capacity. 60 million Americans have an IQ below 85
Even more than that are functionally innumerate
These systems of constraints work especially well when cognitive constraints are higher
Yeah and to add you are not Dave’s target audience. For his target audience cognition around finances are way more expensive than they are for you and most economists.
I have long been annoyed by the "tackle your smallest debt first, ignore rates" advice as being obviously incorrect math, but when you're Average Joe and need to fix your emotional relationship with money, that can be life changing advice. Another manifestation of that thinking is in paying off your mortgage as quickly as possible, even if your index fund is returning at a higher rate than your mortgage: it might not make financial sense, but there is a psychological comfort in fully owning your house that makes you feel financially in control of your life.
He is totally wrong on debt. I would advise everyone to take a 30 year credit as long the interest is below 5%. If it’s interesting is above 15% I would highly advise them against it. Everything in between has room for debate
Important topic, but strange to see an argument in favor of heuristics without mentioning Herb Simon, who amongst other things coined the term "attention economy" as early as 1971, at a time when computers just switched from punchcards to greenscreens. This would also change the angle on the outlook of behavioral economics, since the Carnegie tradition (Simon-Cyert-March) on cognitive limits works from a very different premise than the doomed Berkeley tradition (Akerlof-Kahneman-Rabin), namely decision making as a task at the intersection between economics and cognitive science.
There's that Felix Chopra paper from 2023 that shows that people reduce household expenditures by 5% when exposed to Ramsey. If we think Ramsay's audience's problem is that they need to be trained (through heuristics) to reduce their spending, then Ramsey is right.
Shakespeare seemed to understand heuristics too. Take Polonius advice to Laertes:
"Costly thy habit as thy purse can buy,
But not express'd in fancy; rich, not gaudy;
For the apparel oft proclaims the man,
And they in France of the best rank and station
Are of a most select and generous chief in that.
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine ownself be true,
And it must follow, as the night the day,
Thou canst not then be false to any man."
All fine and good but heuristics have a cost too and at some point become not worth it. You most definitely should pay your high interest debt off first.
Also: paying your highest-interest debt first is also a very simple heuristic.
Not necessarily. For many, the risk isn't poor optimization or which debt to pay. The risk is giving up on the whole endeavor of reducing debt. Removing an entire bill reduces likelihood of giving up
Yes it's not rational. But Ramsey is not speaking to people who are already doing the obvious, rational things. His is a selected audience
Dave has said this exact thing about his method for many years. Several videos of him explaining it to people.
I try to emphasize this as well when teaching behavioural econ: yes all these things - sunk cost bias, satisficing, recognition heuristic/availability heuristic - are irrational according to standard economic textbooks but they are also ways in which we deal with a world that's probably be a bit too complex for our human brain. There's loads of examples in the work of Gerd Gigerenzer. I often see him a bit as the anti-Tversky&Kahneman...
Nicely put. You graciously spared Dave Ramsey's of his actual errors, which involve overly constraining heuristics. Such as: never borrow to buy assets. I lost my bet as I was reading your post, however, as I was certain you'd cite Alchian's classic - from which you seem to borrow your ending flourish -- Uncertainty, Evolution, and Economic Theory (JPE 1950). (Did I miss it?) Your rendition did get me thinking about how the usefulness of rival systems (socialism v. capitalism, etc.) might be seen by compared how 'far up the stack' the reality constraints force rationalization of the imperfect decisions being made. With government expenditures, for example, low valued results might obtain over considerable activities for long periods, whereas with tight private household or firm budget constraints such resource squandering is expected to be mitigated in shorter order. This can be seen as an improvement in dealing with externality inefficiencies, a la Coase, yet another way to state the problem you deal with here.
Even economists maintain the taboo against speaking plainly about how life differs at below average cognitive capacity. 60 million Americans have an IQ below 85
Even more than that are functionally innumerate
These systems of constraints work especially well when cognitive constraints are higher
Yeah and to add you are not Dave’s target audience. For his target audience cognition around finances are way more expensive than they are for you and most economists.
I have long been annoyed by the "tackle your smallest debt first, ignore rates" advice as being obviously incorrect math, but when you're Average Joe and need to fix your emotional relationship with money, that can be life changing advice. Another manifestation of that thinking is in paying off your mortgage as quickly as possible, even if your index fund is returning at a higher rate than your mortgage: it might not make financial sense, but there is a psychological comfort in fully owning your house that makes you feel financially in control of your life.
He is totally wrong on debt. I would advise everyone to take a 30 year credit as long the interest is below 5%. If it’s interesting is above 15% I would highly advise them against it. Everything in between has room for debate
Very interesting