Tarun Ramadorai

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Household finance involves sophisticated financial decisions that most people are not equipped to make – and this needs to change, argues Professor Tarun Ramadorai

Many of us have been through the complex – and frequently baffling – process of buying a home. For most, it is the single biggest financial investment we will ever make and yet the majority go through the experience as financial neophytes.

During his studies, Tarun Ramadorai, Professor of Financial Economics at Imperial College Business School, found it strange that so many of the questions being asked by economists were focused on corporations rather than on how normal people handle their finances.

“Households have to make financial decisions as sophisticated as those made by corporations – without guidance,” Professor Ramadorai says. “We need to find a way to democratise financial tools because these decisions not only have the power to change people’s lives for the better or worse – but they also have macroeconomic implications.”

The financial behaviour of a normal household can often seem illogical to economists

In 2016, armed with this philosophy, Professor Ramadorai analysed the financial behaviour of Indian households, with a view to producing policy recommendations for the insurance, credit, and asset markets at the behest of the Governor of the Reserve Bank of India, Raghuram Rajan.

The Ramadorai Committee sought the answer to two core questions: “What does a typical Indian household balance sheet look like, and what changes are required to best enable Indian households to finance their needs?”

Following this research, the committee’s recommendations included a particularly significant one: that all mortgages being sold should be quoted against a common benchmark. This recommendation now informs the choices of 50 million mortgage applicants in India annually.

Why household finance matters

Economists often choose to focus their work on the US, and it’s hard to blame them. In 2019, the country generated a GDP of $21.43 trillion, accounting for 15.93 per cent of total global GDP the same year.

But for those who want to research household finance and the ramifications the choices of normal people can have on the economy, then thinking about emerging economies, such as India, with its 1.3 billion population, is massively important, says Professor Ramadorai.

Following his work with the Ramadorai Committee, the professor has continued his research into Indian household finance. Particularly interested in further exploring why people make the decisions they do when it comes to their finances, his work crosses over into behavioural economics.

The financial behaviour of a normal household can often seem illogical to economists, he says, adding that understanding it is key because of the wider effect it can have on a country’s economy, such as housing markets becoming stuck.

"We think people make decisions about selling their homes which are heavily based on their preferences in a way that an economist might consider irrational,” he says.

For example, he adds, when it comes to putting a property on the market, the owner is likely to be set on selling for at least the price at which they made the initial purchase. If the markets are falling, however, they are likely to be “very concerned” this won't happen, even though the market price should represent the fair value of the property. If enough people do this, then it can lead to a stagnant housing market, which can have a major impact on a country’s economy.

India in crisis

Growing up in India and witnessing the Asian Financial Crisis in 1997 went a long way towards sparking Professor Ramadorai’s passion for economics. The subsequent economic meltdown that saw many of the tiger economies suddenly doing very badly “raised a set of questions that really gripped me”, he says.

One of the themes of the time that interested him was whether foreign capital flows were destabilising for the economy and responsible for the problems, or whether they were just symptomatic of the underlying issues in those economies. Another was the prevailing view that India’s economy was overregulated, leading him to question to what extent state regulation is helpful or harmful, an interest that ties in with his current work on household finance.

Today, it is another crisis that has raised important questions: during the coronavirus (COVID-19) pandemic, India has experienced one of the worst drops in GDP in the world.

“The amount of fiscal support that has been offered to households – especially poorer ones – is less than we would have liked to have seen,” he says. “The country experienced a stringent lockdown early on and has suffered more economically as a result.”

People have focused on coronavirus but there’s a huge backlog of other treatments in the NHS that need to be done

However, he points out that the government’s response could also provide some opportunities.

“I would like the government to boost post-crisis recovery by bringing in structural reforms, and I believe that they are beginning to do this,” he says.

Similarly, he says, the UK shouldn’t underplay the considerable consequences of lockdown.

“People have focused on coronavirus but there’s a huge backlog of other treatments in the NHS that need to be done, there’s a mental health epidemic – especially among young people, who are our future.”

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About Evie Burrows-Taylor

Evie is Web Content Editor for the Institutional Marketing & Communications team. She is responsible for developing the School's faculty and research communications, working to amplify the School's intellectual leadership to a wide variety of international audiences. She also works on IB Knowledge and the School's news and events coverage.