Working Paper: CEPR ID: DP2561
Authors: Ernst Fehr; Jean-Robert Tyran
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 behavioural 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; nonneutrality of money; sticky prices
JEL Codes: C92; E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| money illusion (E41) | nominal price inertia (E31) |
| nominal framing (D72) | price stickiness after negative nominal shock (E31) |
| real framing (Y60) | price stickiness after negative nominal shock (E31) |
| negative nominal shock (E31) | price expectations resistance (D84) |
| money illusion (E41) | asymmetric effects of nominal shocks (F41) |
| positive nominal shock (E39) | quick price adjustment (D41) |