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Does Money Illusion Matter? An Experimental Approach

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  • Ernst Fehr
  • Jean-Robert Tyran

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.

Suggested Citation

  • Ernst Fehr & Jean-Robert Tyran, 1999. "Does Money Illusion Matter? An Experimental Approach," CESifo Working Paper Series 184, CESifo.
  • Handle: RePEc:ces:ceswps:_184
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    More about this item

    Keywords

    Money illusion; nominal inertia; sticky prices; non-neutrality of money;
    All these keywords.

    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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