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Does Money Illusion Matter?

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Author Info
Ernst Fehr
Jean-Robert Tyran

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Abstract

Money illusion means that people behave differently when the same objective situation is represented in nominal or in real terms. To examine the behavioral impact of money illusion we studied the adjustment process of nominal prices after a fully anticipated negative nominal shock in an experimental setting with strategic complementarity. We show that seemingly innocuous differences in payoff presentation cause large behavioral differences. In particular, if the payoff information is presented to subjects in nominal terms, price stickiness and real effects are much more pronounced than when payoff information is presented in real terms. The driving force of differences in real outcomes is subjects’ expectation of higher nominal inertia in the nominal payoff condition. Due to strategic complementarity, these expectations induce subjects to adjust rather slowly to the shock.

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Paper provided by Institute for Empirical Research in Economics - IEW in its series IEW - Working Papers with number iewwp012.

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Handle: RePEc:zur:iewwpx:012

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Related research
Keywords: : Money illusion; nominal inertia; sticky prices; non-neutrality of money;

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Find related papers by JEL classification:
C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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