Money Illusion and Attitudes Toward Trade

Abstract

This paper argues that being susceptible to money illusion, namely the tendency to think of monetary values in nominal terms rather than real terms, may lead American consumers to hold less favorable impressions of international trade and trade liberalization than they would otherwise hold if they were not susceptible to money illusion. An examination of recent U.S. import price evolution reveals a telling story: over the last decade a number of different imported goods have seen their real prices decline, but due to the presence of inflation, have not seen their nominal prices decline. In the presence of such conditions, an individual who is susceptible to money illusion may misinterpret the lack of nominal import price decreases as a lack of real import price decreases, and therefore view the lack of nominal import price decreases as evidence that recent trade liberalization policies have not been particularly beneficial. A survey-based analysis is employed in order to more rigorously test whether American consumers exhibit this thought process. Furthermore, a model of consumer utility is developed that explores how money illusion may impact changes in utility after the implementation of a new economic policy. The model demonstrates that accounting for the effects of money illusion has a nontrivial impact on the proportion of a population that experiences increases in utility after the implementation of a given policy.