Money Illusion and Coordination

Mekvabishvili, Rati (2006): Money Illusion and Coordination.

Abstract

Non-neutrality of money and stickiness of prices puzzled the economist for decades. The phenomenon of money illusion is one of the central aspects with this regard. Money illusion refers to the tendency to confuse nominal and real aspects of the economy. Our experimental evidences show that even one money illusion prone agent can cause inefficient outcome. Interestingly, we find that under strategic setting money illusion prone subject learns from others behavior. However, the effect of learning under strategic setting seems to be a double-edged; while money illusion free subject learns fast by imitating others to how to overcome money illusion, at the same time her previous actions distorts the aggregate behavior. As it seems, this pattern is largely responsible for the observed stability around unstable equilibrium.

• Item Type: MPRA Paper
• Language: English
• Keywords: Money Illusion, Experiment, coordination
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General; E - Macroeconomics and Monetary Economics > E0 - General > E02 - Institutions and the Macroeconomy; E - Macroeconomics and Monetary Economics > E0 - General > E03 - Behavioral Macroeconomics

References

Fehr, E. and Tyran, J.-R. (2004): Money Illusion and Coordination Failure. Working paper, University of St. Gallen, May 2003

Kahneman, D. and Tversky, A. (2003): Choices, Values and Frames, Cambridge University Press

Shafir, E., Diamond, P.A. and Tversky, A. (1997): Money Illusion. Quarterly Journal of Economics 112(2): 341-74.

Tyran J-B.: Lecture notes, Behavioral and Experimental Economics, University of Copenhagen, winter semester 2004