Experimental Exploration of Money Illusion in Long-term Financial Decision Making

Inadequate consideration of inflation when making long-term financial decisions – so-called money illusion – can have severe consequences for future financial wellbeing. Thus, it is essential to understand how different methods of informing private investors about inflation affect their investment decisions. We propose a novel mechanism for experimental remuneration that can be used to systematically explore money illusion and its consequences. The mechanism imitates the disparity between nominal wealth and real purchasing power by a declining conversation rate. We demonstrate the flexibility and virtues of the new approach through two experimental studies. The objective of the first study is to generate a calibrated measure of money illusion that can be incorporated directly into economic modeling. Meanwhile, the second study is designed to generally explore how behavior in informational settings that are more or less susceptible to money illusion deviates from an unaffected preference benchmark. We find a substantial degree of money illusion in Study 1 and document nuanced behavioral patterns, including meta-cognitive components, in Study 2