Does Money Illusion Matter?: Reply By ERNST FEHR AND JEAN-ROBERT TYRAN*

2013) 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 PW provide a misleading interpretation both of our and their own data. In Fehr and Tyran (FT, 2001), we examine the role of money illusion 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 presence 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 effects across fully anticipated positive and negative shocks. Petersen and Winn (PW, 2012) question our interpretation of the evidence in terms of money illusion and claim that money illusion only plays a slight or no role in post-shock price adjustment. In the following, we challenge PW’s conclusions and argue that PW’s main claims are misleading and no