Financial Literacy and the Financial Crisis

Abstract

The ability of consumers to make
 informed financial decisions improves their chances of
 having sound personal finance. This paper uses a panel
 dataset from Russia, where consumer loans grew at an
 astounding rate -- from about US$10 billion in 2003 to over
 US$170 billion in 2008 -- to examine the importance of
 financial literacy and its relationship with behavior. The
 survey asked questions on financial literacy, consumer
 borrowing (formal and informal), and spending behavior. The
 paper studies the consequences of greater financial literacy
 on the use of financial products and financial planning.
 Even though consumer borrowing rose rapidly in Russia, only
 41 percent of the survey respondents understood how interest
 compounding worked and only 46 percent could answer a simple
 question about inflation. Financial literacy is positively
 related to participation in financial markets and negatively
 related to the use of informal sources of borrowing.
 Individuals with higher rates of financial literacy are
 significantly more likely to report having more unspent
 income at the end of the month and higher spending capacity.
 The relationship between financial literacy and the
 availability of unspent income is more evident during the
 financial crisis, suggesting that better financial literacy
 may better equip individuals to deal with macroeconomic shocks.