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Money Illusion and Coordination Failure

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Author Info
Fehr, Ernst
Tyran, Jean-Robert

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Abstract

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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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 1141.

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Date of creation: 2004
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Handle: RePEc:ces:ceswps:_1141

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Related research
Keywords: money illusion; coordination failure; equilibrium selection; multiple equilibria; coordination games;

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Shafir, Eldar & Diamond, Peter & Tversky, Amos, 1997. "Money Illusion," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 341-74, May.
  2. Giancarlo Marini & Fabrizio Adriani & Pasquale Scaramozzino, 2003. "The Inflationary Consequences of a Currency Changeover: Evidence from the Michelin Red Guide," CEIS Research Paper 27, Tor Vergata University, CEIS. [Downloadable!]
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  3. Ernst Fehr & Jean-Robert Tyran, 2001. "Does Money Illusion Matter?," American Economic Review, American Economic Association, vol. 91(5), pages 1239-1262, December. [Downloadable!] (restricted)
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  4. John C. Harsanyi & Reinhard Selten, 1988. "A General Theory of Equilibrium Selection in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582384.
  5. Kahn, Shulamit, 1997. "Evidence of Nominal Wage Stickiness from Microdata," American Economic Review, American Economic Association, vol. 87(5), pages 993-1008, December. [Downloadable!] (restricted)
  6. Tobin, James, 1972. "Inflation and Unemployment," American Economic Review, American Economic Association, vol. 62(1), pages 1-18, March.
  7. George A. Akerlof, 2002. "Behavioral Macroeconomics and Macroeconomic Behavior," American Economic Review, American Economic Association, vol. 92(3), pages 411-433, June. [Downloadable!]
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  8. Peter Howitt, 2002. "Looking Inside the Labor Market: A Review Article," Journal of Economic Literature, American Economic Association, vol. 40(1), pages 125-138, March. [Downloadable!] (restricted)
  9. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, vol. 76(4), pages 728-41, September. [Downloadable!] (restricted)
  10. Cooper, Russell, et al, 1990. "Selection Criteria in Coordination Games: Some Experimental Results," American Economic Review, American Economic Association, vol. 80(1), pages 218-33, March. [Downloadable!] (restricted)
  11. Campbell, Carl M, III & Kamlani, Kunal S, 1997. "The Reasons for Wage Rigidity: Evidence from a Survey of Firms," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 759-89, August.
  12. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Fabrizio Adriani & Giancarlo Marini & Pasquale Scaramozzino, 2008. "The Inflationary Consequences of a Currency Changeover on the Catering Sector: Evidence from the Michelin Red Guide," Bristol Economics Discussion Papers 08/604, Department of Economics, University of Bristol, UK. [Downloadable!]
    Other versions:
  2. John Duffy, 2008. "Macroeconomics: A Survey of Laboratory Research," Working Papers 334, University of Pittsburgh, Department of Economics, revised Mar 2008. [Downloadable!]
  3. Henk C. Kranendonk & Jan Bonenkamp & Johan P. Verbruggen, 2004. "A Leading Indicator for the Dutch Economy – Methodological and Empirical Revision of the CPB System," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  4. Astrid Hopfensitz & Frans Winden, 2008. "Dynamic Choice, Independence and Emotions," Theory and Decision, Springer, vol. 64(2), pages 249-300, March. [Downloadable!] (restricted)
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  5. Ernst Fehr & Jean-Robert Tyran, . "Expectations and the Effects of Money Illusion," DNB Staff Reports (discontinued) 115, Netherlands Central Bank. [Downloadable!]
  6. Ernst Fehr & Jean-Robert Tyran, 2005. "Individual Irrationality and Aggregate Outcomes," Discussion Papers 05-09, University of Copenhagen. Department of Economics. [Downloadable!]
    Other versions:
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