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Title:Money Illusion and Coordination Failure PDF Logo
Authors:Fehr, Ernst
Tyran, Jean-Robert
Issue Date:2004
Series/Report no.:IZA Discussion paper series 1013
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.
Subjects:money illusion
coordination failure
equilibrium selection
multiple equilibria
JEL:E32
C9
E52
Document Type:Working Paper
Appears in Collections:IZA Discussion Papers, Forschungsinstitut zur Zukunft der Arbeit (IZA)

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