18 / Rotman Management Spring 2017
in cities where price-to-rental ratios seemed most frothy; in-
stead, we saw a period in which lending requirements were
unusually lax.
Of course, in the face of predictable human error, a firm
can take one of two approaches: It can try to teach consumers
about the costs of the error, or it can devise a strategy to exploit
the error. The latter will almost always be more profitable. No
one has ever gotten rich convincing people not to take out an
unwise mortgage. My hope is that people ‘nudge for good’ — as
I write in my book whenever someone asks me to sign it.
How do you define ‘mental accounting’, and what are some of
your key findings in this area?
Simply put, mental accounting is the study of how people spend
money. For me, this has involved observing the way people han-
dle their financial affairs — and noticing all the various ways
that they don’t do it like a professional would. For example,
people often buy things simply because they seem to be a great
deal — not because the product is going to provide enormous
satisfaction. Deep in our closets, many of us have stuff that we
bought at 50 per cent off — that we probably shouldn’t have
bought even if it were free.
Another key finding is that people put their money into dif-
ferent categories; and then, they are often reluctant to spend
money from one ‘pot’ when they need it for another pot. We
behave differently in different circumstances: When we are on
vacation, we easily spend money, even though it is the same
money that will be scarce when we get home. Or, we might use
different monthly budgets for groceries and eating at restau-
rants, for example, and constrain one kind of purchase when
the budget runs out, while not constraining the other — even
though both draw upon the same resource (i.e. your income).
We also found that grocery shoppers spend less when paying
with cash than with their debit or credit cards.
A recent study of CFOs found that they had no ability to
predict stock market returns, and that they also had no self-
awareness about this lack of predictive skill. What are the
implications of this finding?
Sadly, it’s not clear what can be done about it: Overconfidence
is a fact of life. That particular study asked the CFOs to forecast
stock market returns and give an 80 per cent confidence limit —
meaning a range that the correct answer would lie between the
two numbers 80 per cent of the time. What they found is, their
forecast included the right answer about one third of the time.
We see overconfident forecasts all the time. In last fall’s
American election, some forecasters were saying that Hillary
Clinton had a 99 per cent chance of winning — which, even
without the benefit of hindsight, was a ridiculous forecast.What is your message for the critics who feel that nudging is
heavy-handed and unnecessary?
I would tell them that whether they like it or not, there is no
avoiding nudging — or choice architecture. Take a school caf-
eteria, for example: Someone has to arrange and display the
food; it can’t just be presented randomly — unless you want
the kids to spend their entire time looking for something to eat.
That is choice architecture in action, and it applies to just about
everything in the economy and in society.
When nudges are used in the business arena, I do believe
that companies need to be sure the choice architecture they use
is transparent, and not a deliberate attempt to induce custom-
ers to make a poor choice. A key feature of responsible nudg-
ing is to make sure that all default options are easily reversible.
If you are suggesting people enroll in a pension plan because
you believe that they would do so if they had the knowledge
and willpower to make a good choice — and if they can get out
of it with one mouse click — then, little harm done. But if the
user has to make three phone calls and then walk across town
to find the office where they have to fill out a long form in order
to undo something, that is not acceptable.
My Nudge co-author Cass Sunstein and I really hope that
an understanding of choice architecture and the power of
nudges will lead people to think of creative ways to improve hu-
man lives in all sorts of domains: Workplaces, corporate boards,
universities and even families might be able to use, and benefit
from, small exercises in what we call ‘libertarian paternalism’.Looking ahead, you have said ‘Behavioural Macroeconomics’
is at the top of your wish list. Please explain.
In my view, Macroeconomics is stuck where Economics was 30
years ago, with models of Econs, even though the policies that
emerge from it affect humans. Fortunately, this is beginning
to change, and if we continue to apply Behavioural Econom-
ics tools to the study of Macroeconomics, we might be able to
prevent the next global financial crisis. Or, at the very least,
have a better sense of how to deal with it, when it happens.You have also said that the term Behavioural Economics will
likely vanish from our lexicon one day. Why is that?Choice architecture applies to just about everything
in the economy and in society.