An Experimental Study of Money Illusion in Intertemporal Decision Making

Abstract

To examine the degree to which price fluctuations affect how individuals approach an intertemporal decision-making problem, we conduct a laboratory experiment in which subjects spend their savings on consumption over 20 periods. In the control treatment, the commodity price is constant across all periods. In the small (large) price-fluctuation treatment, the price rate of change is always 1% (20%), and the rate of change of savings is always the same as the commodity price. Therefore, the optimal amount of consumption is the same in all three treatments. Our main findings are threefold. First, the magnitude of misconsumption (i.e., the deviation from optimal consumption) is significantly high in order of the control, small price-fluctuation, and large price-fluctuation treatments. Second, in the control treatment, the magnitude of misconsumption shrinks over time, whereas it gradually increases in the small and large price-fluctuation treatments. Finally, regardless of the presence of price fluctuations, subjects exhibit under-consumption (over-saving) behavior, and the presence of price fluctuations strengthens such a tendency.

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