We assume that people often think of economic transactions in both nominal and real terms, and that the monetary illusion arises from the interaction between these representations, resulting in a bias towards nominal valuation. Key Points The money illusion posits that people tend to view their wealth and income in nominal dollar terms rather than recognizing their true value when adjusted for inflation. [Sources: 5, 7]
The illusion of money is a psychological problem because people are biased and think in name rather than actual monetary value, because it may indicate the illusion of higher purchasing power. The monetary illusion is an economic theory that assumes that people tend to view their wealth and income in nominal dollars rather than actual values. Currency illusion, also known as price illusion, is an economic theory that states that people tend to view their income and wealth in name rather than reality. However, although they can distinguish between surface value and actual value, why they suffer from the illusion of money has not been well debated. [Sources: 0, 5, 8, 12]
The tendency to think in terms of the face value of a coin, without taking into account changes in its real value, underlies the phenomenon known as money illusion (MI). It is sometimes said that employers take advantage of this by modestly raising wages in nominal terms without paying more in real terms. Although it is impossible to give an answer about the existence or absence of MI and about determining the speed of propagation in a given economic context, the impact on the economy resulting from the effects of the money illusion, it is undeniable that the decisions made by the agents are equally important. Economic depends largely on the ability / ability to distinguish between nominal and real value. [Sources: 2, 5]
In particular, in an environment where economic entities are prone to currency illusions, the decline in inflation may lead to the impact of rising housing prices. Some people disagree with this theory, believing that people will automatically consider their money in actual value to adapt to inflation, because they will see price changes every time they walk into the store. Another way to think about the concept of monetary illusion is to assume that people do not consider the effects of inflation. Inflation is an economic concept, which refers to the increase in the level of commodity prices over a period of time. [Sources: 0, 2, 5]
In Monetary Illusion and Housing Madness, economists Brunnermeier and Juilliard examined the relationship between property values and inflation by compiling price-rent ratios and identifying an adequate measure of mispricing in the real estate market. The increase in the nominal amount of money creates the illusion that you have become richer. These phenomena exacerbate a lack of information about how much our incomes need to grow to stay flat, creating further negative bias in how we value ourselves. The illusion of money is prized by entrepreneurs and economists precisely because it is dangerous for people: it allows employers to “appear” to be increasing wages to workers, when in fact they may or may not pay the same once, which takes inflation into account. [Sources: 2, 6, 9]
This is a constant occurrence, even for highly capable people such as professional investors, and causes significant cumulative nominal inertia. In investment, higher inflation makes people less afraid of losing money, as they tend to value losses in nominal terms. The money illusion is a key concept that Milton Friedman included in his version of the Phillips curve. The Phillips curve is a graphical representation of the short-term relationship between unemployment and inflation in an economy, which is one of the economic tools that describe the inverse relationship. between unemployment and inflation. Fischer concluded that people think of their wealth in nominal terms and not in reality, which creates a false sense of security for personal wealth. [Sources: 0, 8, 10]
If we think about money in nominal terms and are attached to the past, we will underestimate ourselves. There are many possible psychological biases that confuse economic agents in their decisions when they are made through the veil of money. If this is not corrected for inflation, more and more people will be attracted to the system over time. Thus, we confuse the nominal value of money with its purchasing power. [Sources: 2, 6, 9, 10]
No one seems to realize that with the existing formula, older people have achieved what can be described as unjustifiable adjustments to their benefits, measured in real rather than nominal terms. For example, prior to the 1980s, income tax thresholds were not indexed, with the result that when inflation increased the nominal incomes of people, they were automatically transferred to higher tax categories and the income went to the treasury, without which no one particularly complained. Suppose you invested a certain amount of money in stocks, say 1,000. As a result, many people who receive a wage increase believe that their wealth will increase regardless of the actual rate of inflation. [Sources: 6, 9, 10]
This shows that people are very willing to accept data that supports their biased bubble theory. A basic principle of economics is that people always like wider opportunities. Now, of course, just because most people believe in bubbles even if they do not exist, there is no evidence that they do not exist. Research has shown that even in data generated following a random walk, people will see bubbles. [Sources: 4, 11]
However, I will make some positive suggestions in terms of economic policy and economic research. The British economist John Maynard Keynes was praised for helping popularize the term. I wrote a series of posts saying that people are programmed to look for patterns that don’t exist. [Sources: 4, 5, 11]
— Slimane Zouggari
##### Sources #####
[0]: https://corporatefinanceinstitute.com/resources/knowledge/economics/money-illusion/
[1]: https://www.jstor.org/stable/2951239
[2]: https://www.bankpedia.org/index_voce.php?lingua=en&i_id=114&i_alias=m&c_id=23294-money-illusion-encyclopedia
[3]: https://www.yourdictionary.com/money-illusion
[4]: https://www.themoneyillusion.com/confirmation-bias-and-bubbles/
[5]: https://www.investopedia.com/terms/m/money_illusion.asp
[6]: https://breakingdownfinance.com/finance-topics/behavioral-finance/money-illusion/
[7]: https://collaborate.princeton.edu/en/publications/money-illusion-3
[8]: https://doaj.org/article/8dddc71b7bb54192be4a0f2d7e81e7fb
[9]: https://www.stayingeven.com/what-are-money-illusion-and-anchoring
[10]: https://www.brookings.edu/opinions/money-illusion-the-chained-cpi-and-the-benefits-of-inflation/
[11]: https://www.econstor.eu/handle/10419/222009
[12]: https://policonomics.com/money-illusion/