The role of financial literacy in reducing financial distress: What if consumers were perfectly financially literate?

Abstract

Using longitudinal data from the Panel Study of Income Dynamics (PSID), this study examines the extent to which financial literacy can mitigate financial distress. Employing a “what if” analysis, we simulate the effect of maximizing financial literacy on the likelihood of experiencing financial distress. We show that raising financial literacy to its highest level could prevent financial distress for a group of households facing moderate financial distress. Our results also imply that financial literacy is not a panacea for consumers' financial problems as those facing high risk of financial distress seem to be not affected by financial literacy. Interventions beyond financial literacy might be needed to effectively address financial distress.