Money Illusion and Coordination Failure

Economists long considered money illusion to be largely irrelevant. Here we show, however, that money illusion has powerful effects on equilibrium selection. If we represent payoffs in nominal terms, choices converge to the Pareto inefficient equilibrium; however, if we lift the veil of money by representing payoffs in real terms, the Pareto efficient equilibrium is selected. We also show that strategic uncertainty about the other players? behavior is key for the equilibrium selection effects of money illusion: even though money illusion vanishes over time if subjects are given learning opportunities in the context of an individual optimization problem, powerful and persistent effects of money illusion are found when strategic uncertainty prevails.

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Year of publication:	2004
Authors:	Fehr, Ernst ; Tyran, Jean-Robert
Publisher:	Bonn : Institute for the Study of Labor (IZA)
Subject:	Geldillusion \| Marktmechanismus \| Gleichgewicht \| Pareto-Optimum \| Spieltheorie \| Experiment \| money illusion \| coordination failure \| equilibrium selection \| multiple equilibria

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Series:	IZA Discussion Papers ; 1013
Type of publication:	Book / Working Paper
Type of publication (narrower categories):	Working Paper
Language:	English
Other identifiers:	378770241 [GVK] hdl:10419/20248 [Handle]
Classification:	E32 - Business Fluctuations; Cycles ; C9 - Design of Experiments ; E52 - Monetary Policy (Targets, Instruments, and Effects)
Source:	EconStor