Optimism and debt overload

Throughout the last crisis, there has been much talk about excessive borrowing by individuals (and countries), and how this seems to follow some irrational behavior. We have to understand here that irrationality is a very strong concept, in the sense that people would knowingly take decisions that are against their best interest. I am not saying this does not happen, but ignorance and wrong beliefs can lead to behavior that looks irrational but is in fact perfectly rational.

Ari Hyytinen and Hanna Putkuri explore some data from Finland and find that those who borrow excessively do so because they are much more optimistic about future outcomes. Believing that future incomes will be high seems a perfectly rational justification for borrowing, especially when the lender seems to share this assessment. What is more worrisome though is that those overly optimistic households have more difficulties revising their expectations when faced with evidence. Maybe they hate it to be proven wrong (who does not?). Maybe it is Finnish bankruptcy law that encourages them to go for broke once a point of no return is reached. The latter would be perfectly rational again.