Money illusion is the belief that an increase in wages guarantees life is better for the individual. This ideal, of course, has not considered inflation.
Nowadays people are far more in touch with what is happening in the economy.
TRADE UNIONS: Trade unions consider inflation when bargaining for wages. Trade unions are becoming more sophisticated in their wage negotiations and often factor in inflation expectations. However, even unions can be influenced by public opinion and political pressures, which may not always align with sound economic principles.
INFORMED INDIVIDUALS: Even individuals have access to many information sources not previously seen, specialized news reporting agencies, both on TV and in print form and of course the Internet. Those who are financially literate and actively monitor economic trends are better equipped to adjust their expectations and demands to account for inflation. However, not everyone has the time, resources, or inclination to do so.
Why does money illusion exist?
However, it important to consider that money illusion still persists to some extent, even in today’s information-rich environment. Here is a breakdown of why money illusion still exists:
- Cognitive Biases: Humans are prone to cognitive biases, including the tendency to focus on nominal values rather than real values. This can lead to misinterpretations of wage increases, especially when inflation is low or gradual.
- Limited Financial Literacy: Despite increased access to information, financial literacy levels vary widely. Many individuals may not fully understand the impact of inflation on their purchasing power.
- Psychological Factors: People may feel a sense of satisfaction and accomplishment from a higher nominal wage, even if its real value has not increased. This can be especially true for those who are less financially savvy or have limited experience with inflation.
- Short-Term Thinking: Some individuals may focus on immediate gains from a wage increase without considering the long-term effects of inflation.
While the prevalence of money illusion may have decreased over time due to increased access to information and education, it still remains a relevant economic phenomenon.
To mitigate its effects, continued efforts are needed to improve financial literacy, promote critical thinking, and encourage long-term perspectives in economic decision-making.
