Go to the Globe and Mail homepage

Jump to main navigationJump to main content

Report on Business

Economy Lab

Delving into the forces that shape our living standards
Best Business Blog, EPPY awards, 2011 and 2012

Entry archive:

Economy Lab has moved

Only Globe Unlimited members will now have access to a wide range of insightful commentary
and analysis on the economy and markets previously offered on this page.


Globe Unlimited subscribers will be able to read these columns,
written by some of Canada’s most deeply respected economists,
such as Christopher Ragan, Sheryl King, Andrew Jackson, and Clement Gignac,
as part of our ROB INSIGHT section.


All of our readers will still be able to browse the Economy Lab archives and read our
broader coverage of economic data and news by accessing their 10 free articles a month.


Learn more about Globe Unlimited and how to subscribe.

Too many people confuse face value with purchasing power (Ed Ou/Associated Press)
Too many people confuse face value with purchasing power (Ed Ou/Associated Press)

Money illusion – comparing apples with apples Add to ...

It is idiotic to report that Apple Inc. is now the biggest company in history by market capitalization. At $850-billion (U.S.), dotcom-era Microsoft remains the record holder in today’s money. But those ignoring the effect of inflation are unwittingly at the centre of a long-running academic debate with contemporary implications for how monetary policy could help create jobs. That debate is over what economists call money illusion.

More Related to this Story

Money illusion as defined by Irving Fisher in 1928 is when people think of money in nominal rather than real terms. That is, mistaking the face value of something (Apple’s market cap) with purchasing power (what Apple’s market cap could actually buy). Money illusion was used to explain why nominal wages could be sticky: why workers might be happy to accept a 2-per-cent wage increase even though inflation is running at 4 per cent.

Money illusion also underpinned the early Phillips Curve, a theory that suggested policy makers face a trade-off between inflation and unemployment. (Companies hire more in times of inflation because workers do not realize they are becoming cheaper in real terms.) But then Milton Friedman came along and said the idea was hogwash. Of course the supply of labour depends on real wages – employees adapt to inflation. The concept of money illusion was abandoned, as was the idea that long-run unemployment might be reduced via inflation.

A few decades later money illusion began a revival. Behavioural economists showed that people really do get confused about numbers in all kinds of ways. Further studies showed money illusion to exist at different levels of inflation in certain countries. Some economists now think that regions with entrenched unemployment, such as the U.S. and the euro zone, with 8.3 and 11.2 per cent respectively, should risk giving higher targeted inflation a go. Apple’s share price saves the world!

Follow us on Twitter: @GlobeBusiness

 
Security Price Change
AAPL-Q Apple 97.114 0.084
0.087 %
Add to watchlist
Live Discussion of AAPL on StockTwits
More Discussion on AAPL-Q

Topics:

In the know

Most popular video »

Highlights

More from The Globe and Mail

Most Popular Stories