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Discussion Paper Details

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Title: Does Money Illusion Matter? An Experimental Approach

Author(s): Ernst Fehr and Jean-Robert Tyran

Publication Date: September 2000

Keyword(s): Money Illusion, Nominal Inertia, Non-Neutrality Of Money and Sticky Prices

Programme Area(s): International Macroeconomics

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.

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Bibliographic Reference

Fehr, E and Tyran, J. 2000. 'Does Money Illusion Matter? An Experimental Approach'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=2561