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BOK Working Paper No.2021-8, Money Illusion: Evidence from Korea

Economic Research Institute (02-759-5475) 2021.06.28 359

Title : Money Illusion: Evidence from Korea
Author : Ohik Kwon(BOK), Kyusik Kim(BOK), In Do Hwang(BOK)

<Abstract>

This paper tests whether Korean households exhibit money illusion by surveying a representative sample of the adult population, 500 men and women living in the nation. Money illusion refers to the tendency to think and assess in terms of nominal monetary values, rather than real values controlling for inflation. When the survey questions from the existing money illusion literature were used, compelling evidence of money illusion was found: A majority of respondents relied on the change in nominal rather than real prices when assessing the profitability of transactions of houses, consumer goods, and financial products. However, evidence inconsistent with the money illusion hypothesis was also found in the answers to questions in a different context where nominal prices were not explicitly presented: When asked whether they would like to change their investment plan in a situation where inflation was present, respondents answered rationally that they would change the investment portfolio in consideration of inflation. We further found evidence consistent with the rational inattention phenomenon—the lower the experienced inflation, the stronger the respondent’s money illusion. In addition, respondents were found to have various behavioral biases other than money illusion, such as loss aversion, reference dependence, and framing effects.

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