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Discussion Paper Details

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Title: Money Illusion and Coordination Failure

Author(s): Ernst Fehr and Jean-Robert Tyran

Publication Date: March 2004

Keyword(s): coordination failure, coordination games, equilibrium selection, money illusion and multiple equilibria

Programme Area(s): International Macroeconomics

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 pay-offs in nominal terms, choices converge to the Pareto inefficient equilibrium; however, if we lift the veil of money by representing pay-offs in real terms, the Pareto efficient equilibrium is selected. We also show that strategic uncertainty about the other players? behaviour 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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Bibliographic Reference

Fehr, E and Tyran, J. 2004. 'Money Illusion and Coordination Failure'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=4283