Money Illusion
🇳🇴PengeillusjonDefinition
Money illusion is the tendency to think about money in nominal amounts rather than real purchasing power. A 3% raise in a year with 5% inflation *feels* like a gain, even though you've actually lost purchasing power.
Real-world example
Shafir, Diamond, and Tversky (1997) showed the effect most clearly. Two people take jobs at the same starting salary. Ann gets a 2% raise in a year with 0% inflation. Barbara gets a 5% raise in a year with 4% inflation. In real terms Ann is better off, but most respondents say Barbara has the better deal – because 5 is bigger than 2.
The effect shapes real decisions: employees fiercely resist nominal pay cuts, but readily accept a frozen salary in a high-inflation year – economically the same thing. Housing markets over time, pension savings, and negotiations are all colored by the illusion.
Supplementary perspective
The illusion isn't stupidity – nominal figures *are* the numbers we see every day. Translating to real purchasing power takes mental effort, and the brain takes shortcuts. In low-inflation periods the cost is small. In high-inflation periods it can cost you a lot.
Practical advice
Recognize
- —Notice if you're happy about a raise without checking inflation.
- —Be skeptical of 'price X years ago' without adjusting for price growth.
- —Check whether your investment return is real or just nominal.
Counteract
- —Always compute salary changes in real terms (nominal – inflation).
- —Compare historical prices in today's currency value, not the currency of their time.
- —Use real returns when evaluating investments and pensions.
Ethical use
- —In salary negotiations: ask for inflation linkage, not just nominal percent.
- —In communication: be explicit whether a number is nominal or real.
- —In planning: budget for purchasing power, not just currency.