Money Illusion and Coordination Failure

For decades economists have considered money illusion aslargely irrelevant. Here we show, however, that money illusion haspowerful effects on equilibrium selection. If we represent payoffs innominal terms almost all subjects play at or close to an inefficientequilibrium whereas if we lift the veil of money by representing payoffs inreal terms almost all subjects choose the efficient equilibrium. Moreover,we show that strategic interaction is key for the equilibrium selectioneffects of money illusion. Even though individual-level money illusionvanishes over time in a non-strategic setting, powerful and persistenteffects of money illusion are found in a strategic setting.