LECTURE:10

Money IIlusion

MONEY ILLUSION

Money illusion is the mistaken belief that money is stable – as in fixed – in real value over. In
other words, the numerical/face value (nominal value) of money is mistaken for its purchasing
power (real value).
The term was coined by Keynes in the early twentieth century, and Irving Fisher wrote an
important book on the subject, The Money Illusion, in 1928.The existence of money illusion is
disputed by monetary economists who contend that people act rationally ( i.e. think in real
prices) with regard to their wealth.
money illusion influences economic behavior in three main ways:
• Price stickiness. Money illusion has been proposed as one reason why nominal prices are
slow to change even where inflation has caused real prices or costs to rise.
• Contracts and laws are not indexed to inflation as frequently as one would rationally
expect.
• Social discourse, in formal media and more generally, reflects some confusion about real
and nominal value.
money illusion implies that the negative relationship between inflation and unemployment
described by the Phillips curve might hold, contrary to recent macroeconomic theories.
Attachments:

Prepared by MBA\MRS R.CHITRA[ASSISTANT PROFESSOR\TSBA004]

03/12/09