research

How does financial distress relate to mental health?

A TFI research project by Olga Goldfayn-Frank & Yuri Pettinicchi
Posted on July 14, 2020

"How does financial distress relate to mental health?" is one of the short-term research projects supported by the Think Forward initiative.

Mental health has been recognized as one of the major challenges facing individuals and society today. It it therefore important to understand how mental and financial well-being are related. Researchers Olga Goldfayn-Frank and Yuri Pettinicchi investigate how mental health may affect financial decisions (or vice versa), and show which measures could help households to alleviate financial distress.

Download the report below to read more.

SUMMARY


As societies carefully tread their way out of the Covid-19 lockdown, mental stress takes its toll. In the USA, a federal emergency hotline for people in emotional distress registered a whopping 1,000 percent increase in April compared with the same time last year.1 In US polls, as much as half of the respondents report negative changes in their mental health because of the pandemic. Health experts worldwide, government bodies and organizations like the UN and the OECD warn about the global mental health crisis2, which is anticipated to have a profound effect on people’s lives in the years to come.

Coupled with the precarious financial situation that many households find themselves in these days, the relation between people's mental health and financial distress of their household becomes of central importance. In our research project, we use two large representative surveys3 covering 12 European countries and the United Kingdom to study this issue. We attempt to understand the link between psychological distress and financial outcomes, which may support policymakers and financial practitioners in devising beneficial practices and solutions to confront the challenge of managing one's mental health and one's household finances.


The link between mental health and financial distress

We find that psychological health has a strong and robust relation with the financial well-being of the household, even when also considering differences among households in wealth, income, age, employment and education. In fact, contrary to the common wisdom of “old, poor and sick”, the link between mental health and financial distress persists for both rich and poor, as well as men and women, young and old alike (see Figures 1 and 2).


Olga-figure-1.1.PNG#asset:14910


Olga-figure-2.1.PNG#asset:14901

It appears that the relation we observe between financial and emotional well-being is at least partially due to episodic events of mental distress, which could be burn-out, higher level of anxiety or stress-related conditions. Indeed, the data shows that among various manifestations of mental health problems, depression, lack of interest and lack of sleep appear to have strongest link with financial distress.

While the evidence of the relation between mental and financial distress is strong and economically meaningful, it is difficult to figure out whether financial difficulties cause emotional problems, or vice versa. Do psychological issues lead to financial mistakes? It is likely that mental health and financial problems perpetuate one another, forming a vicious circle (Cocco, Gomes & Lopes, 2019).

On the one hand, financial problems, insecurity about unemployment or future income cause strong anxieties, and possibly depression. Studies show that suicide rate goes up during economic downturns (Norström & Grönqvist, 2015). On the other hand, managing one's finances is a complex task, and for people who face mental stress, financial matters become even more challenging. Even moderate mental health issues may make daily tasks extremely complicated, such as paying (credit card) bills on time or taking care of saving plans.


The power of self-efficacy

What could help to break this vicious circle? What appears to lessen the bind between mental health and financial distress is not so much the ability4, but the belief about one's ability to control the situation and perform well. These are the characteristics related to a basic personality trait called self-efficacy. In other studies, people with higher self-efficacy – a stronger belief that they can influence their own future – have been shown to make better financial decisions (Bogan & Fertig, 2017; Kuhnen & Melzer, 2018) as well as achieve better academic results even under mental stress (Hernández et al., 2019).

At the same time, people seem to realize that psychological problems such as anxiety or depression will influence the quantity or quality of their work. This subjective underperformance has a strong relation with financial distress of the household. We also find evidence that people who have mental health issues are more likely to delegate their financial responsibilities. However, it appears that delegation to a spouse or a partner does not bring financial benefits.

So which alternative measures could help households to alleviate financial distress? Since psychological interventions may result in better economic choices (Heckman, Pinto & Savelyev, 2013), targeted measures designed to boost people's confidence and self-efficacy for their financial management could be beneficial. In times of the Covid-related social-distancing measures, automated financial assistance and advice could go a long way to help households struggling with financial management. Saving schemes with commitment devices as well as automated debt repayment arrangements could help ease the debt stress.

Footnotes

  1. https://www.washingtonpost.com/health/2020/05/04/mental-health-coronavirus/
  2. https://www.weforum.org/agenda/2020/05/united-nations-global-mental-health-crisis-covid19-pandemic/
  3. The first survey (SHARE) is a large European cross-country survey covering the elder part of the population (50+), from 2004 up to 2017 (bi-annually). The second survey is representative of the UK population, since 1991 (annual). Both surveys measure - amongst other factors - mental health and the households' financial state.
  4. We find that better memory, for instance, does not influence the relation between mental health and financial distress, while one’s ability to accomplish tasks has only limited effect.

References

  • Cocco, J. F., Gomes, F., & Lopes, P. (2019). Evidence on Expectations of Household Finances. SSRN Electronic Journal. doi: 10.2139/ssrn.3362495
  • Norström, T., & Grönqvist, H. (2015). The Great Recession, unemployment and suicide. J Epidemiol Community Health, 69(2), 110-116.
  • Bogan, V. L., & Fertig, A. R. (2017). Mental health and retirement savings: Confounding issues with compounding interest. Health Economics, 27(2), 404–425.
  • Kuhnen, C. M., & Melzer, B. T. (2018). Noncognitive abilities and financial delinquency: The Role of self‐efficacy in avoiding financial distress. The Journal of Finance, 73(6), 2837-2869.
  • Hernández, A. L., González Escobar, S., González Arratia López Fuentes, N. I., & Barcelata Eguiarte, B. E. (2019). Stress, Self-Efficacy, Academic Achievement and Resilience in Emerging Adults.
  • Heckman, J., Pinto, R., & Savelyev, P. (2013). Understanding the mechanisms through which an influential early childhood program boosted adult outcomes. American Economic Review, 103(6), 2052-86.