Money illusion, financial literacy and numeracy: Experimental evidence

Money illusion is usually defined as the inability of individuals to correctly account for inflation or deflation when making decisions. Empirical evidence shows that money illusion matters in financial decisions, particularly those made by households. In this article, we analyze money illusion at the individual level within the context of financial choices and study its relationship with numeracy and financial literacy. To do so, we propose an original measure of money illusion via an experimental task. This task consists of a series of choices between a pair of simple bonds whose returns are affected only by inflation (or deflation). We provide a fine-grained measure of money illusion that is correlated with typical measures (questionnaires) of it. Moreover, we show that money illusion depends on the choice context (e.g., inflation or deflation) and participants' abilities. Individuals with financial knowledge are less sensitive to money illusion than others, while there is no evidence of an impact of numeracy.