Does Money Illusion Matter?: Reply† By Ernst Fehr and Jean-Robert Tyran*

show that money illusion plays an important role in nominal price adjustment after a fully anticipated negative monetary shock. Money illusion affects subjects ’ expectations, and causes pronounced nominal inertia after a negative shock but much less inertia after a positive shock. Thus Petersen and Winn (2014) provide a misleading interpretation of both our and their own data. (JEL C92, D83, D84, E31, E32, E52) In Fehr and Tyran (2001)—henceforth, FT—we examine the role of money illu-sion in the adjustment of nominal prices after a fully anticipated monetary shock in a price setting game with strategic complementarity. We show that nominal prices adjust much more slowly to the new equilibrium after a negative shock in the pres-ence of the “veil of money, ” i.e., when we present payoff information in nominal terms compared to when we present it in real terms. In contrast, nominal prices adjust relatively quickly to the new equilibrium after a positive monetary shock even under the veil of money, suggesting that money illusion exerts asymmetric effect