Imagining performing an action can induce false memories of having actually performed it—this is referred to as the imagination-inflation effect. Drawing on research suggesting that action observation—like imagination—involves action simulation, and thus creates matching motor representations in observers, we examined whether false memories of self-performance can also result from merely observing another person’s actions. In three experiments, participants observed actions, some of which they had not performed earlier, and took a source-memory test. Action observation robustly produced false memories of self-performance relative to control conditions. The demonstration of this effect, which we refer to as observation inflation, reveals a previously unknown source of false memories that is ubiquitous in everyday life. The effect persisted despite warnings or instructions to focus on self-performance cues given immediately before the test, and despite elimination of sensory overlap between performance and observation. The findings are not easily reconciled with a source-monitoring account but appear to fit an account invoking interpersonal motor simulation.