Money Illusion and Strategic Complementarity as Causes of Monetary Non-Neutrality

by Tyran, Jean-Robert

• ISBN13: 9783540658719
• ISBN10: 3540658718
• Format: Paperback
• Copyright: 1999-09-01
• Publisher: Springer Verlag

Summary

In principle, money illusion could explain the inertial adjustment of prices after changes of monetary policy. Hence, money illusion could provide an explanation of monetary non-neutrality. However, this explanation has been thoroughly discredited in modern economics. As a consequence, economists have ever since the 1970s searched for alternative explanations for nominal rigidity. These explanations are all based on the assumption of fully rational economic agents, holding rational expectations. This book argues that money illusion has been prematurely dismissed as an explanation of monetary non-neutrality. Methods of experimental economics are used to investigate the real aggregate effects of money illusion. It is shown that money illusion in fact causes (short-run) real income effects if strategic complementarity prevails. Strategic complementarity is an important characteristic of naturally occurring macroeconomies and is a recurrent theme in most models explaining nominal rigidity.

Table of Contents

Introduction	1	(4)
Part I Approaches to the Problem of Monetary Non-Neutrality	5	(46)
Empirical evidence on the non-neutrality of money from macroeconomic data	9	(6)
Selected evidence on the (non-)neutrality of money	10	(2)
Problems of empirical work in monetary macroeconomics	12	(3)
Mismeasurement in macroeconomic aggregates
Problems of isolating causalities
Theories of nominal rigidity and monetary non-neutrality	15	(7)
Explaining monetary non-neutrality and nominal rigidity by assuming that all agents are fully rational	16	(4)
Explaining monetary non-neutrality by assuming that some agents are not fully rational	20	(2)
Money illusion	22	(14)
The psychology behind money illusion	25	(3)
Potential relevance of money illusion to economics	28	(8)
Money illusion as a disequilibrating force
Labor markets
Further areas where money illusion may be of economic relevance
Why can money illusion and strategic complementarity cause monetary non-neutrality?	36	(10)
Bounded rationality and monetary non-neutrality
Money illusion and strategic properties
Summary of part I and hypotheses	46	(5)
Summary	46	(2)
Hypotheses	48	(3)
Part II Experimental Study	51	(28)
Are experiments in macroeconomics possible?	53	(7)
What is experimental economics?
What is an experimental design?
Macroeconomics as an indirectly experimental science
Experimental design to isolate causes of monetary non-neutrality	60	(19)
General description of the experimental design	60	(2)
Experimental procedures and parameters	62	(4)
Description of treatments	66	(10)
Variation of representation	66	(6)
Real representation
Semi-real representation
Nominal representation
Variation of the strategic property	72	(4)
Advantages of the present experimental design in the investigation of monetary non-neutrality	76	(3)
Part III Results of Experimental Study	79	(66)
Non-neutrality with strategic complementarity	81	(15)
Nominal rigidity
Monetary non-neutrality
Best reply behavior
Price expectations
Loss decomposition
Subjective confidence in price expection
Summary of chapter 1
Does money illusion matter?	96	(23)
Specification of hypotheses to be tested	97	(1)
The effect of nominal representation given strategic complementarity	98	(16)
Nominal rigidity
Monetary non-neutrality
Best reply behavior
Price expectations
Confidence in price expectation
The effect of representation given strategic substitutes	114	(3)
Nominal rigidity
Monetary non-neutrality
Summary of chapter 2	117	(2)
The effects of strategic complements and strategic substitutes	119	(21)
Specification of hypotheses to be tested	119	(4)
Specification of hypothesis HA2
Specification of hypothesis HA3
The effect of strategic substitutes vs. complements when the environment is represented in nominal terms	123	(12)
Nominal rigidity
Monetary non-neutrality
Best reply behavior
Price expectations
Confidence in price expectations
The effect of strategic properties when the environment is represented in real terms	135	(5)
Nominal rigidity
Monetary non-neutrality
Best reply behavior and expectations
Summary of results	140	(5)
Part IV Discussion of Results	145	(24)
Empirical relevance of results	147	(12)
Biases in favor of monetary neutrality
Biases against monetary neutrality?
Extensions and suggestions for further research
Implications for economic theory and policy	159	(10)
Money illusion and the rationality paradigm	159	(4)
Implications for macroeconomic theory	163	(2)
Implications for economic policy	165	(4)
Appendices	169	(42)
Appendix A1. Instructions	170	(9)
Appendix A2. Income tables	179	(21)
Appendix A3. Mathematical appendix	200	(11)
References	211	(12)
List of tables	223	(1)
List of figures	224	(2)
Author index	226