Hostname: page-component-78c5997874-v9fdk Total loading time: 0 Render date: 2024-11-13T22:46:01.983Z Has data issue: false hasContentIssue false
  • English
  • Français

MONEY ILLUSION AND MARKET SURVIVAL

Published online by Cambridge University Press:  16 October 2015

Roland Eisenhuth
Roland Eisenhuth*
Affiliation:
Oregon State University
*
Address correspondence to: Roland Eisenhuth, School of Public Policy—Economics Program, Oregon State University, 303 Ballard Extension Hall, Corvallis, OR 97331, USA; e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

By studying complete and incomplete dynamic financial markets, I show that if some agents are money-illusioned and neglect inflation, the rational agents who are aware of inflation are driven out of the market in the long run, in the sense that the money-illusioned agents consume the economy's entire endowment. The reason for this finding is that with inflation, the money-illusioned agents always believe that the return on their savings is higher than it actually is. Because these agents trade financial assets in markets with the rational agents, the rational agents end up being borrowers and the money-illusioned agents lenders. Because the rational agents' debt accumulates over time, they become so indebted that the money-illusioned agents eventually consume the economy's entire endowment. If there is deflation, the opposite is true, and the rational agents evolutionarily dominate.

Keywords

Money IllusionEvolutionary SurvivalMonetary PolicyInflation
Type
Articles
Information
Macroeconomic Dynamics , Volume 21 , Issue 1 , January 2017 , pp. 1 - 10
Copyright
Copyright © Cambridge University Press 2015 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Basak, Suleyman and Yan, Hongjun (2010) Equilibrium asset prices and investor behaviour in the presence of money illusion. Review of Economic Studies 91, 914–936.CrossRefGoogle Scholar
Fehr, Ernst and Tyran, Jean-Robert (2001) Does money illusion matter? American Economic Review 91, 1239–1262.CrossRefGoogle Scholar
Genesove, David and Mayer, Christopher (2001) Loss aversion and seller behavior: Evidence from the housing market. Quarterly Journal of Economics 16, 1233–1260.CrossRefGoogle Scholar
Sandroni, Alvaro (2000) Do markets favor agents able to make accurate predictions? Econometrica 68, 1303–1341.CrossRefGoogle Scholar
Sandroni, Alvaro (2005) Market selection when markets are incomplete. Journal of Mathematical Economics 41, 91–104.CrossRefGoogle Scholar
Shafir, Eldar, Diamond, Peter, and Tversky, Amos (1997) Money illusion. Quarterly Journal of Economics 112, 341–374.CrossRefGoogle Scholar
Weber, Bernd, Rangel, Antonio, Wibral, Matthias, and Falk, Armin (2009) The medial prefrontal cortex exhibits money illusion. Proceedings of the National Academy of Sciences 106, 5025–5028.CrossRefGoogle ScholarPubMed
Yan, Hongjun (2008) Natural selection in financial markets: does it work? Management Science 54, 1935–1950.CrossRefGoogle Scholar