Akerlof (1970), The Market for 'Lemons': Quality Uncertainty and the Market Mechanism. Shiller (2009), How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, Princeton University Press, Ainslie (1975) Specious reward: A behavioral theory of impulsiveness and impulsive control.
G - Financial Economics > G0 - General > G01 - Financial Crises G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulationī - History of Economic Thought, Methodology, and Heterodox Approaches > B0 - General > B00 - General G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation Money Illusion Imperfect Financial Markets Regulatory Failure Behavioural Finance The Problem of Money Illusion in Economics Money illusion is so as well an expression that unfounded optimism about the self-regulatory discipline of market participates is sufficient to stop financial markets get out of control to an historical unprecedented level. By weakening the regulatory framework, failing to establish transparency and accountability of agents eager to get rich as fast as possible without taking into regard the rules of good governance the current global financial crisis of institutional failure to contain the instability of financial markets to an acceptable social level. The complacency of monetary authorities of the past decades to do so, has not primarily a diagnostic problem to deal with money illusion, but even more so with vested interests of insiders of private investors on the institution to control unlawful behaviour. The author, however, considers that there are some early warning indicators which would give the possibility of timely action of policy makers to control financial market bubbles. If monetary policy fails to control for irrational exuberance of investors about the future benefits and profits of such innovations, this inherently embodies the risk of a financial market shock, if expectations of the general public have to adjust after overoptimistic prediction about the future economic development. The recent financial market bubbles are significantly related to such general purpose innovations. the ICT revolution with the Internet or the introduction of securitization as a means to redistribute risk as general purpose innovations make valuations of the long term to medium term impacts on the economy extremely difficult. One reason for this is that in standard economic reasoning the problem of intentional cheating is neglected. Because of these imperfections the possibility of significant long-lasting valuation problems emerges. However, financial markets are imperfect as Minsky has pointed out. Since money is the unit of account, accounting problems related to the uncertain nature of future economic development makes a continuous readjustment of valuations in money units necessary. The author of this paper suggests that financial markets are particular engaged in intertemporal valuation problems which are common to any kind of economic activity.
However, it still needs a better understanding why monetary phenomena especially related to financial markets play an important role in understanding the real economy, the production, consumption and exchange of commodities and services. Now, it has become a respected fact to accept money illusion as a stylized fact of human behaviour. However, with the gradual diffusion of behavioural economics based on experimental research this has changed. Money illusion in economic theory has been an assumption rejected for academic economists for quite some time.
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