The Grand Delusion: How Money Illusion Makes Us All Look Silly (and Poor)

The Grand Delusion: How Money Illusion Makes Us All Look Silly (and Poor)

> “I got a raise!”

“Oh really? How much?”

“5%! I’m rich now!”

“But inflation is 6%...”

“...Wait, what?”

Welcome to the world of Money Illusion — where numbers deceive, logic takes a vacation, and you celebrate being poorer as if it’s Diwali. In this wonderfully confusing corner of economics, people behave as though money has the same value all the time. Spoiler: it doesn’t.

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What is Money Illusion, Anyway?

Money Illusion is the tendency of people to think in nominal terms (face value) rather than real terms (adjusted for inflation).

Let me put it simply: If your boss tells you your salary went up from ₹50,000 to ₹55,000, you're thrilled. But if prices all around you have jumped by 15%, you’ve essentially been handed a beautifully wrapped pay cut. And yet — you smile, you treat yourself to a milkshake, and maybe you even thank your boss.

Isn’t economics fun?

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Proof of the Illusion: The Science Behind the Silly

Economists like Irving Fisher and later Akerlof, Dickens, and George "The Yoda of Economics" Akerlof have shown that people, markets, and even policymakers regularly fall for this illusion.

In a famous study, people considered a 2% wage increase with 4% inflation “better” than a 2% wage cut with 0% inflation, even though the latter leaves your real income unchanged. The reason? Feelings. People hate wage cuts (even if their money buys more), and love wage increases (even if their money buys less). Logic packs its bags and leaves the economy.

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Indian Masala: Money Illusion Desi Style

Imagine a mallu uncle in Kerala.

> "Ithu kaalam nannayirikkunnu. My pension increased ₹500!"

But milk is now ₹10 more per litre, onions are behaving like gold, and even coconut oil requires EMI. Yet, uncle is feeling richer because the number is higher. Never mind that his dosa budget has collapsed.

In India, where inflation rates can quietly sneak into your kitchen like uninvited relatives, money illusion is a national sport. Salary hikes in government sectors, DA adjustments, and real estate pricing all happily ignore real purchasing power.

Ever heard someone say, “In 1995, I bought land in Kochi for ₹50,000, and now it’s worth ₹50 lakhs” — as if inflation didn’t exist? That’s not just nostalgia; that’s textbook money illusion in action.

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Why It Matters (Beyond Causing Confusion and Laughter)

Money illusion isn't just a party trick economists use to laugh at us in research papers. It has serious implications:

1. Sticky Wages: Employees resist nominal wage cuts, even if inflation-adjusted wages are unaffected. So employers avoid cutting wages → unemployment rises.

2. Policy Failures: Central banks must navigate around the illusion. A 3% inflation target may be a psychological cushion to allow “real” wage adjustments without tantrums.

3. Asset Bubbles: People invest in assets based on nominal returns. Real return? That’s tomorrow’s problem.

4. Election Campaigns: Politicians promise higher pensions and subsidies — no mention of the rising cost of living. Classic illusion-based strategy. Effective too.

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So, Are We All Just Foolish?

Not exactly. We evolved in a world of barter, not CPI charts. The average person didn’t evolve with an inflation calculator in their DNA. But today, understanding money illusion is essential — especially when your favorite chocolate bar keeps shrinking, even as its price remains the same. (Looking at you, Dairy Milk.)

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My Verdict: Embrace the Truth, Laugh at the Illusion

So next time your HR says, “Congrats! You got a 4% raise,” just smile, nod, and ask, “How much did prices rise?” That’s how you stop being the punchline in the comedy that is money illusion.

Because as every economist knows, money talks — but it often lies.