Does Money Illusion Matter? An Experimental Approach

69 Pages Posted: 5 Jun 2008  

Ernst Fehr

University of Zurich - Department of Economics

Jean-Robert Tyran

University of Vienna; University of Copenhagen - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: July 2000

Abstract

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

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

Ernst Fehr (Contact Author)

University of Zurich - Department of Economics ( email )

Bl├╝mlisalpstrasse 10
Zuerich, 8006
Switzerland
+41 1 634 3709 (Phone)
+41 1 634 4907 (Fax)

Jean-Robert Tyran

University of Vienna ( email )

Oskar-Morgenstern-Platz 1
Vienna, Vienna 1090
Austria

HOME PAGE: http://homepage.univie.ac.at/jean-robert.tyran/

University of Copenhagen - Department of Economics ( email )

├śster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark
+45 353 23 027 (Phone)

HOME PAGE: http://www.econ.ku.dk/tyran/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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