How People Respond to the Changes in Nominal and Real Values in the Presence of Money Illusion?—Evidence from an Experiment in Japan—

Abstract

This paper presents how people under money illusion are affected by currency’s real and nominal values. The most fundamental question in this paper is whether or not individuals pay attention to real values even when they are under the influence of money illusion. The experiment conducted in Japan showed that people are indifferent to the slight difference of real and nominal values, but as the difference becomes greater, they become more conscious of it and begin to incorporate real values. In addition, inflation and deflation have asymmetric effects: people hate nominal salary decreases in deflation more than they enjoy nominal salary increases in inflation, which can be defined as nominal loss aversion. Nominal loss aversion implies that money illusion is more serious under deflation than under inflation.