Perceiving the Real Value: Inflation Communication, Money Illusion, and the Attractiveness of Investing
52 Pages Posted: 7 Nov 2019 Last revised: 12 Apr 2021
Date Written: August 26, 2019
In retirement planning, the ignorance of inflation – so-called money illusion – can have severe consequences for future financial wellbeing. It thus seems important to make private investors aware of the divergence between future nominal wealth and real purchasing power. Surprisingly, existing research has hardly explored how different approaches to communicate inflation information affect behavior in long-term investment scenarios. To close this gap, we introduce a novel mechanism for experimental remuneration that mimics the divergence between nominal wealth and real purchasing power by a declining conversation rate. This mechanism allows to elicit investors’ unbiased preferences and to explore the deviations in informational settings that are more or less susceptible to money illusion. We predict that long-term investment products look overly attractive in conditions that foster the occurrence of money illusion and hypothesize that this bias is particularly strong for investment profiles with (nominal) money-back guarantees. The experimental data delivers only partial support for these predictions. Participants seem to understand that their attempts to adjust the long-term nominal returns for the annual inflation rate are susceptible to error. As a consequence they avoid extreme (high or low) investment levels and show an investment behavior that is not sufficiently sensitive to differences in the investment products’ (unbiased) attractiveness. We discuss policy implications and avenues for follow-up research.
Keywords: savings behavior, money illusion, experimental methods
JEL Classification: C91, D14, D83, D91
Suggested Citation: Suggested Citation