Intentions rather than money illusion – Why nominal changes induce real effects

Research on the Phillips curve has so far largely neglected the link to reciprocity and intentions. To fill this gap, we investigate a gift-exchange game in the laboratory under conditions of the classical dichotomy: An aggregate increase in nominal wages leaves aggregate real wages unchanged. To implement this, the real wage an employee receives is determined by the nominal wage divided by inflation (the average wages paid to others). We find that aggregate effort increases in response to increased aggregate nominal wages, which corresponds to the logic of the Phillips curve. This violation of the classical dichotomy persists even in a treatment that provides full information. Employees reciprocate increases in nominal wages (which are set intentionally) even if the effect on real wages is outbalanced by inflation (which arises unintentionally). In a treatment in which we remove intentions by using computerized employers, we do not observe this effect. This implies that the effect is driven by intentions and not money illusion. Our findings contribute to a behavioral foundation of the Phillips curve.