Money illusion

The term money illusion describes the non-perception of inflation ( inflation surprise ) by economic agents, ie which are under the illusion that the money still to have the same value. Since the economic subjects but should include information on price increases by statistics and our own experience, it is at the money illusion is a temporary phenomenon (freedom from money illusion ).

Importance

Importance attained the phenomenon money illusion mainly in two contexts:

Money illusion and monetary policy

Due to the delayed perception of inflation by the economic agents is a task of monetary policy is to give the person concerned a possible long-term and highly credible forecast of general price trends. This can be " prevented " from a business perspective, that the uncertainty of employees is reflected in higher wage demands as a precaution.

Nonetheless, the central bank can temporarily exploit in its monetary policy, the reputation it enjoys with the economic agents. So they could cause, for example, in times of stable prices and low wage growth by an expansionary monetary policy an unexpected higher inflation. The price increases then cause the wages of the employees go back real. For companies, this means (again, real) lower production costs.

If a central bank pursue next price targets and labor market objectives, because lower production costs may could lead to the hiring of new workers, then offers a caused by her surprise inflation. However, these are a very dubious economic success, as the central bank wreaks mehrerlei damage: First, the duration of a money illusion is temporary, so that wage earners will try after a certain time, to compensate for their real income loss due to higher wage demands. This in turn means that unemployment rises again to its previous level and the overall effect is only temporary. This problem is treated in the modified order expectations Phillips curve. Secondly, the Central Bank harm by such a policy may themselves as they thus destroyed their reliability: If the central bank once causes a surprise inflation, so it seems plausible that they will try the same policy for a second time. For this reason, may increase the long-term inflation expectations of economic agents and thus their wage demands, so that in the long term not less but even more unemployment could be the result.

These effects include many economists that it should not be the task of the central bank to take advantage of the money illusion of wage earners and other economic agents. Rather, they should explain to people just because of reliability and credibility.

Money illusion and wage negotiations

In the presence of wage increases the affected employees expect a larger real income. This they spend part of what stimulates the Aggregate demand in the case of full employment and perfect capacity utilization in the economy. As reflected in such a situation, higher wages delayed in higher prices, the real added value of wages to inflation is eaten again (wage inflation).

The economic policy challenge is therefore to limit the realized inflation and to break a vicious cycle of ever higher inflation and higher and higher wage demands ( in the presence of high inflation ).

However, one can speak of money illusion in this case only partially, because a) first, there is a real added value and because b ) the delayed inflation can be perceived by the wage earners well.