69 Pages Posted: 5 Jun 2008
Date Written: July 2000
Money illusion means that people behave differently when the same objective situation is represented in nominal terms rather than in real terms. This paper shows that seemingly innocuous differences in payoff representation cause pronounced differences in nominal price inertia indicating the behavioral importance of money illusion. In particular, if the payoff information is presented to subjects in nominal terms, price expectations and actual price choices after a fully anticipated negative nominal shock are much stickier than when payoff information is presented in real terms. In addition we show that money illusion causes asymmetric effects of negative and positive nominal shocks. While nominal inertia is quite substantial and long-lasting after a negative shock, it is rather small after a positive shock.
Keywords: Money Illusion, Nominal Inertia, Sticky Prices, Non-Neutrality of Money
JEL Classification: C92, E32, E52
Suggested Citation: Suggested Citation
Fehr, Ernst and Tyran, Jean-Robert, Does Money Illusion Matter? An Experimental Approach (July 2000). IZA Discussion Paper No. 174; CESifo Working Paper Series No. 184. Available at SSRN: https://ssrn.com/abstract=250116 or http://dx.doi.org/10.2139/ssrn.250116