📈 economics

Who's in? Household-targeted Government Policies and the Role of Financial Literacy in Market Participation

This paper utilizes the 2012 Italian retail Treasury bond introduction as a proxy for Central Bank Digital Currency to demonstrate that households with low financial literacy are more likely to adopt new government-backed financial instruments, a finding supported by a theoretical model showing that such households allocate more wealth to CBDC while high-literacy households prefer risky assets for risk management.

Original authors: Maria Elena Filippin

Published 2026-02-23

📖 5 min read🧠 Deep dive

CC BY 4.0

Original authors: Maria Elena Filippin

Original paper licensed under CC BY 4.0 (http://creativecommons.org/licenses/by/4.0/). ✨ This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer

Imagine the financial world as a giant, bustling marketplace. For a long time, many regular people (households) have been standing on the sidelines, afraid to enter because the rules are confusing, the entry fees seem high, or they just don't understand the games being played. This is the problem of financial literacy.

This paper asks a big question: If the government builds a new, special lane in this marketplace, who will actually use it? And more importantly, does knowing how to read the map (financial literacy) change who walks through the door?

Here is the story of the paper, broken down into simple parts with some helpful analogies.

1. The Mystery of the "New Lane" (The Problem)

Central banks around the world are thinking about launching a CBDC (Central Bank Digital Currency). Think of this as a "digital dollar" or "digital euro" issued directly by the government, sitting in your phone like cash, but safer and more modern.

But here's the catch: No one has launched a real one yet. It's like a chef trying to predict how people will react to a new flavor of ice cream before they've even tasted it. We don't have data on who will buy it.

2. The "Time Machine" Solution (The Proxy)

Since the author can't wait for the future, she uses a "time machine" to look at a similar event from the past.

The Event: In 2012, the Italian government introduced a special type of bond just for regular people (retail Treasury bonds).
The Analogy: Imagine the government built a special, easy-to-access "Community Garden" for growing vegetables. Before this, you had to know a complex code to get into the expensive "Private Greenhouse." The Community Garden was free, safe, and designed for everyone.
The Goal: The author used data from Italy to see: When this new, easy garden opened, who started planting seeds? Was it the people who knew nothing about gardening, the experts, or the people who knew a little bit?

3. The Surprising Discovery (The Results)

The author looked at the data and found a very interesting pattern. It wasn't a straight line where "more knowledge = more participation."

The Clueless (Financially Illiterate): These folks stayed on the sidelines. Even with the new easy garden, they didn't know how to start or were too scared to try.
The Experts (High Financial Literacy): These folks were already busy in the "Private Greenhouse" (stocks and complex investments). The new Community Garden was too simple for them; they didn't need it.
The "Almost There" Group (Low but Some Literacy): This is the surprise winner. These are people who know just enough to understand the new garden exists and how to enter, but they don't have the complex tools to play in the high-risk markets.
- The Metaphor: Imagine a video game. The "Noobs" don't know the controls. The "Pros" are playing on the hardest difficulty. The "Casual Players" (the low-literacy group) finally found a game mode that was just right for them, so they jumped in immediately.

The Finding: When a new, government-backed financial tool is introduced, the people with some but low financial literacy are actually the most likely to start using it.

4. The Theory: Why Does This Happen? (The Model)

To explain why this happens, the author built a simple computer model (a theoretical story) with two types of characters:

The Risk-Taker (High Literacy): This person has a "magic shield" (access to risky assets like stocks). If they lose money in the garden, they can make it back in the stock market. Because they have this safety net, they don't need the new government garden as much. They use it only for a little bit of extra cash.
The Cautious Saver (Low Literacy): This person cannot enter the stock market (too scary or too complicated). Their only safety net is a bank account. When the new government garden (CBDC) opens, it's the best safe place they have ever seen. They put a huge chunk of their money there because they have nowhere else safe to go.

The Twist: If the future looks scary (income uncertainty), even the "Risk-Taker" gets nervous. They drop their "magic shield" (stocks) and run to the safe government garden, just like the cautious saver.

5. What Does This Mean for the Future? (The Takeaway)

The paper concludes with a message for the people designing these new digital currencies (CBDCs):

Don't assume everyone is an expert: The people who will adopt this new technology the fastest aren't the finance wizards; they are the regular folks who are almost there but need a little help.
Communication is Key: Since the "Almost There" group is the most responsive, the government needs to explain the new tool in a way that bridges the gap between "confused" and "expert." If the instructions are too hard, the "Noobs" won't come. If the tool is too complex, the "Pros" won't care.
Safety First: For people who can't access risky investments, a government-backed digital currency acts as a vital safety net.

In a nutshell:
When the government opens a new, safe financial door, the people who are most eager to walk through it are those who know a little bit about money but don't have access to the fancy, high-risk investment clubs. They are the "Goldilocks" of finance—not too scared, not too expert, just right. Understanding this helps governments design better tools for everyone.

1. Problem Statement and Motivation

The paper addresses the limited participation of households in financial markets, a phenomenon that generates welfare costs. While government policies aimed at households can stimulate participation, the specific role of financial literacy in these adoption decisions remains under-explored, particularly regarding new government-backed instruments like Central Bank Digital Currency (CBDC).

The Gap: There is a lack of empirical data on CBDC adoption because most central banks have not yet issued retail CBDCs. Consequently, it is difficult to understand how household heterogeneity (specifically financial literacy) influences the demand for such instruments.
The Core Question: How does financial literacy affect a household's likelihood of engaging with a new, government-backed retail financial instrument? Does this relationship follow a linear pattern (higher literacy = higher adoption) or a non-linear one?

2. Methodology

The paper employs a mixed-method approach, combining empirical analysis using a natural experiment with a theoretical structural model.

A. Empirical Strategy: The Proxy Approach

Due to the absence of CBDC data, the author uses the 2012 introduction of retail Treasury bonds in Italy (Buoni del Tesoro Poliennali - Italia) as a proxy.

Rationale: Both retail Treasury bonds and CBDC are government-backed, household-oriented instruments accessible via institutional channels (banks/digital wallets). While Treasury bonds are investment vehicles and CBDC is often viewed as a payment tool, the adoption mechanism (evaluating a new public instrument against existing assets) is comparable.
Data Source: Bank of Italy's Survey on Household Income and Wealth (SHIW), utilizing panel data from waves 2010 and 2012 (administered in 2013).
Financial Literacy Measure: Constructed using the "Big Three" questions (interest rates, inflation, risk diversification). Households are categorized into four levels:
- Score 0: Financially illiterate.
- Score 1: Low financial literacy.
- Score 2: High financial literacy.
- Score 3: Financially expert.
Econometric Model: A Generalized Linear Model (GLM) with a logit link function is used to estimate the probability of participation (binary outcome). The model includes an interaction term between the policy dummy (post-2012) and the initial financial literacy score to capture heterogeneous treatment effects. Controls include demographics, risk aversion, and time fixed effects.

B. Theoretical Framework: Two-Agent Endowment Economy

To explain the empirical findings and project them onto CBDC, the author develops a two-period, two-agent model:

Agents:
- High-Financially Literate (HFL): Can invest in risk-free deposits, risky assets, and CBDC.
- Low-Financially Literate (LFL): Restricted to risk-free deposits and CBDC (cannot access risky assets due to information costs/complexity).
Preferences: Agents maximize discounted expected lifetime utility derived from consumption and liquidity services (modeled via a CES aggregator for deposits and CBDC).
Scenarios: The model analyzes portfolio allocation under:
1. Deterministic Income: Second-period income is known.
2. Stochastic Income: Second-period income is uncertain (risk of loss), forcing agents to hedge.
CBDC Design: Modeled as interest-bearing but with a return lower than deposits ( $R_m < R_d$ ), reflecting current central bank considerations.

3. Key Results

Empirical Findings (Italy Retail Bonds)

Positive but Non-Monotonic Effect: Financial literacy positively influences participation in the Treasury bond market after the policy introduction, but the effect is non-monotonic.
- Low-Literacy Households (Score 1): Show the highest increase in participation probability (odds increase by ~80% relative to the illiterate baseline).
- High-Literacy Households (Score 2 & 3): Show a smaller increase (~25% and ~57% respectively).
- Illiterate Households (Score 0): Show the lowest participation.
Portfolio Reallocation: The introduction of retail bonds caused a shift in portfolios. Households reallocated funds from other government securities and stocks toward the new retail Treasury bonds.
Interpretation: The "sweet spot" for adoption appears to be households with some financial literacy. They possess enough knowledge to overcome entry barriers (e.g., opening an account, understanding the instrument) but lack the sophistication to find superior alternative investments, making the new government-backed instrument highly attractive. Highly literate households may already hold diversified portfolios or find the new instrument's returns less attractive compared to other opportunities.

Theoretical Findings (CBDC Model)

Liquidity vs. Risk-Sharing:
- LFL Agents: Since they cannot access risky assets to hedge income risk, they rely heavily on safe liquid assets. Consequently, they allocate a larger share of their wealth to CBDC compared to HFL agents, even when CBDC returns are lower than deposits.
- HFL Agents: Use risky assets to hedge against income risk. When income is uncertain, they shift away from risky assets toward safer options (including CBDC), but their overall CBDC allocation remains lower than that of LFL agents because they have access to higher-yielding risky assets.
Convergence under Uncertainty: As income uncertainty increases, HFL agents reduce their exposure to risky assets and increase holdings in safe liquid assets (CBDC), narrowing the gap with LFL agents, though LFL agents still hold more CBDC.
Robustness: The results hold even if CBDC is non-interest-bearing. The liquidity motive drives adoption for LFL agents regardless of the interest rate differential, provided the return is not negative.

4. Key Contributions

Empirical Evidence on Heterogeneity: Provides the first evidence that the impact of government financial policies on market participation is non-linear with respect to financial literacy. It challenges the assumption that higher literacy always leads to higher adoption of new public instruments.
CBDC Adoption Insights: Bridges the gap between financial literacy literature and CBDC research. It offers a theoretical framework suggesting that low-to-moderate literacy households may be the primary early adopters of CBDC as a store of value, driven by a lack of access to other safe assets.
Policy Proxy Validation: Successfully validates the use of retail Treasury bond data as a proxy for understanding CBDC adoption dynamics, specifically regarding household heterogeneity and entry barriers.

5. Significance and Policy Implications

Targeted Communication: Policymakers designing CBDC must recognize that "one size fits all" communication may fail. The "low-literate" group is highly responsive but requires clear, accessible onboarding to overcome informational frictions.
Financial Inclusion: CBDC could serve as a crucial financial inclusion tool for households that are excluded from complex investment markets but possess enough literacy to engage with simple, government-backed digital instruments.
Design Considerations: The model suggests that even non-interest-bearing CBDCs can achieve significant adoption among low-literacy households due to their liquidity and safety attributes. However, to prevent bank disintermediation, quantitative limits or specific design features (e.g., tiered remuneration) might be necessary, though these are not explicitly modeled here.
Broader Market Impact: The findings suggest that introducing new government instruments can lead to significant portfolio reallocations, potentially crowding out other assets (stocks, other bonds) depending on the literacy profile of the participating households.

In summary, the paper argues that financial literacy acts as a filter for market participation. While high literacy enables access to complex markets, a moderate level of literacy combined with a new, accessible government instrument creates a "sweet spot" for adoption, a dynamic that is likely to repeat with the introduction of retail CBDCs.