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An Experimental Study of Money Illusion in Intertemporal Decision Making

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  • Tetsuo Yamamori
  • Kazuyuki Iwata
  • Akira Ogawa

Abstract

To examine the degree to which price fluctuations affect how individuals approach an intertemporal decision-making problem, we conduct a laboratory experiment in which subjects spend their savings on consumption over 20 periods. In the control treatment, the commodity price is constant across all periods. In the small (large) price-fluctuation treatment, the price rate of change is always 1% (20%), and the rate of change of savings is always the same as the commodity price. Therefore, the optimal amount of consumption is the same in all three treatments. Our main findings are threefold. First, the magnitude of misconsumption (i.e., the deviation from optimal consumption) is significantly high in order of the control, small price-fluctuation, and large price-fluctuation treatments. Second, in the control treatment, the magnitude of misconsumption shrinks over time, whereas it gradually increases in the small and large price-fluctuation treatments. Finally, regardless of the presence of price fluctuations, subjects exhibit under-consumption (over-saving) behavior, and the presence of price fluctuations strengthens such a tendency.

Suggested Citation

  • Tetsuo Yamamori & Kazuyuki Iwata & Akira Ogawa, 2014. "An Experimental Study of Money Illusion in Intertemporal Decision Making," Working Papers e85, Tokyo Center for Economic Research.
  • Handle: RePEc:tcr:wpaper:e85
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    References listed on IDEAS

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    1. Houser, Daniel & Winter, Joachim, 2004. "How Do Behavioral Assumptions Affect Structural Inference? Evidence from a Laboratory Experiment," Journal of Business & Economic Statistics, American Statistical Association, vol. 22(1), pages 64-79, January.
    2. Allen, Todd W. & Carroll, Christopher D., 2001. "Individual Learning About Consumption," Macroeconomic Dynamics, Cambridge University Press, vol. 5(02), pages 255-271, April.
    3. Stephen Johnson & Laurence J. Kotlikoff & William Samuelson, 1987. "Can People Compute? An Experimental Test of the Life Cycle Consumption Model," NBER Working Papers 2183, National Bureau of Economic Research, Inc.
    4. Charles N. Noussair & Gregers Richter & Jean-Robert Tyran, 2008. "Money Illusion and Nominal Inertia in Experimental Asset Markets," Discussion Papers 08-29, University of Copenhagen. Department of Economics.
    5. 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 728-741, September.
    6. Binswanger, Johannes, 2011. "Dynamic decision making with feasibility goals: A procedural-rationality approach," Journal of Economic Behavior & Organization, Elsevier, vol. 78(3), pages 219-228, May.
    7. Matthew E. Kahn, 2005. "The Death Toll from Natural Disasters: The Role of Income, Geography, and Institutions," The Review of Economics and Statistics, MIT Press, vol. 87(2), pages 271-284, May.
    8. Binswanger, Johannes, 2012. "Life cycle saving: Insights from the perspective of bounded rationality," European Economic Review, Elsevier, vol. 56(3), pages 605-623.
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Negative Nominal Interest Rates (again)
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2016-08-22 19:13:27

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