Don’t Ignore Inflation Ignorance: An Experimental Analysis of the Degree of Money Illusion in Individual Decision Making

61 Pages Posted: 13 Feb 2018 Last revised: 6 Jul 2019

See all articles by Nicole Branger

Nicole Branger

University of Muenster - Finance Center Muenster

Henning Cordes

University of Muenster - Finance Center

Thomas Langer

University of Muenster - Finance Center

Date Written: July 2, 2019

Abstract

Money illusion refers to the tendency to evaluate economic transactions in nominal rather than real terms. One manifestation of this phenomenon is the tendency to neglect future inflation in intertemporal investment decisions. Empirical evidence for this “inflation ignorance” is hard to establish due to the host of factors that simultaneously change with the inflation rate. We avoid these identification issues by conducting a controlled and fully incentivized investment experiment. We measure a substantial degree of money illusion and show that it is not driven by lacking diligence, arithmetic problems, or misunderstandings of inflation. Instead, participants seem to anchor subconsciously to nominal returns, even though they are unambiguously incentivized to base their decisions on real returns only. Our findings contribute towards understanding various anomalies on the individual and market level, such as insufficient savings efforts or equity mispricing.

Keywords: Money illusion, financial decision making, asset allocation.

JEL Classification: C91, D11, D14, D91

Suggested Citation

Branger, Nicole and Cordes, Henning and Langer, Thomas, Don’t Ignore Inflation Ignorance: An Experimental Analysis of the Degree of Money Illusion in Individual Decision Making (July 2, 2019). Available at SSRN: https://ssrn.com/abstract=3105976 or http://dx.doi.org/10.2139/ssrn.3105976

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

Henning Cordes (Contact Author)

University of Muenster - Finance Center ( email )

Universitätsstr. 14-16
Muenster, 48143
Germany
+49 251 83 22058 (Phone)

Thomas Langer

University of Muenster - Finance Center ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 22033 (Phone)

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