This paper studies, theoretically and experimentally, the effects of overconfidence and fake news on information aggregation and the quality of democratic choice in a common-interest setting. We theoretically show that overconfidence exacerbates the adverse effects of widespread misinformation (i.e., fake news). We then analyze richer models that allow for partisanship, targeted misinformation intended to sway public opinion, and news signals correlated across voters (due to media ownership concentration or censorship). In our experiment, overconfidence severely undermines information aggregation, suggesting that the effect of overconfidence can be much more pronounced at the collective than at the individual level.

Much evidence suggests that people are heterogeneous with regard to their abilities to make rational, forward-looking decisions. This raises the question as to when the rational types are decisive for aggregate outcomes and when the boundedly rational types shape aggregate results. We examine this question in the context of a long-standing and important economic problem: the adjustment of nominal prices after an anticipated monetary shock. Our experiments suggest that two types of bounded rationality—money illusion and anchoring—are important behavioral forces behind nominal inertia. However, depending on the strategic environment, bounded rationality has vastly different effects on aggregate price adjustment. If agents' actions are strategic substitutes, adjustment to the new equilibrium is extremely quick, whereas under strategic complementarity, adjustment is both very slow and associated with relatively large real effects. This adjustment difference is driven by price expectations, which are very flexible and forward-looking under substitutability but adaptive and sticky under complementarity. Moreover, subjects' expectations are also considerably more rational under substitutability.

Much evidence suggests that people are heterogeneous with regard to their abilities to make rational, forward-looking decisions. This raises the question as to when the rational types are decisive for aggregate outcomes and when the boundedly rational types shape aggregate results. We examine this question in the context of a long-standing and important economic problem: the adjustment of nominal prices after an anticipated monetary shock. Our experiments suggest that two types of bounded rationality—money illusion and anchoring—are important behavioral forces behind nominal inertia. However, depending on the strategic environment, bounded rationality has vastly different effects on aggregate price adjustment. If agents' actions are strategic substitutes, adjustment to the new equilibrium is extremely quick, whereas under strategic complementarity, adjustment is both very slow and associated with relatively large real effects. This adjustment difference is driven by price expectations, which are very flexible and forward-looking under substitutability but adaptive and sticky under complementarity. Moreover, subjects' expectations are also considerably more rational under substitutability.

The data in Fehr and Tyran (2001) and Petersen and Winn (2014) show that money illusion plays an important role in nominal price adjustment after a fully anticipated negative monetary shock. Money illusion affects subjects' expectations, and causes pronounced nominal inertia after a negative shock but much less inertia after a positive shock. Thus Petersen and Winn (2014) provide a misleading interpretation of both our and their own data.

This paper shows that a small amount of individual-level money illusion may cause considerable aggregate nominal inertia after a negative nominal shock. In addition, our results indicate that negative and positive nominal shocks have asymmetric effects because of money illusion. While nominal inertia is quite substantial and long lasting after a negative shock, it is rather small after a positive shock.