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Money illusion means that people behave differently when the same objective situation is represented in nominal or in real terms. To examine the behavioral impact of money illusion we studied the adjustment process of nominal prices after a fully anticipated negative nominal shock in an experimental setting with strategic complementarity. We show that seemingly innocuous differences in payoff presen- tation cause large behavioral differences. In particular, if the payoff information is presented to subjects in nominal terms, price stickiness and real effects are much more pronounced than when payoff information is presented in real terms. The dri- ving force of differences in real outcomes is subjects' expectation of higher nominal inertia in the nominal payoff condition. Due to strategic complementarity, these expectations induce subjects to adjust rather slowly to the shock.

Does Money Illusion Matter? An Experimental Approach