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The money (currency) illusion.

Discussion in 'Personal' started by lexus300, Dec 29, 2015.

  1. lexus300

    lexus300 Star commenter

    I have just read an interesting article which in summary form states:

    Money illusion is a longstanding concept in economics that has enormous significance if you’re a saver or investor.
    The money illusion is a tendency of individuals to confuse real and nominal prices. It boils down to the fact that people ignore inflation when deciding if they are better off. EG.,
    Assume you are a builder working for a property management company making £100,000 per year. You get a 2% pay increase, so now you are making £102,000 per year. Most people would say they are better off after the pay increase. But if inflation is 3%, the £102,000 salary is worth only £98,940 in purchasing power relative to where you started.

    The difference between your perception and reality is money illusion.

    The concept of money illusion as a subject of economic study and policy is not new. Irving Fisher, one of the most famous economists of the 20th century, wrote a book called The Money Illusion in 1928. The idea of money illusion can be traced back to Richard Cantillon’s Essay on Economic Theory of 1730, although Cantillon did not use that exact phrase.

    The fallacy:

    Economists argue that money illusion does not exist. Instead, they say, you make decisions based upon “rational expectations”. That means once you perceive inflation or expect it in future, you will discount the value of your money and invest or spend it according to its expected intrinsic value.

    Central bankers use the 'money illusion' to transfer wealth from a saver and/or investor to debtors. They do this when the economy isn’t growing because there’s too much debt.
    Central bankers try to use inflation to reduce the real value of the debt to give debtors some relief in the hope that they might spend more and help the economy get moving again. Of course, this form of relief comes at the expense of savers and investors who see the value of their savings/assets decline.

    Confiscation by stealth:

    Assume the Bank of England engineers 3% inflation for five years, for a total of 15% inflation. The saver who has £100,000 in the bank at the beginning now has in effect, only £85,000 in purchasing power due to inflation.
    So, actual confiscation would be politically unacceptable, whilst inflation of 3% per year is barely noticed. In effect, inflation thus created in a deflationary cycle is a hidden tax used to transfer wealth from savers to debtors without causing the political headaches of a real tax increase.

    The big question that no one asks is why do central banks such as the Bank of England pursue 'money illusion' policies?
  2. lexus300

    lexus300 Star commenter

  3. eggyspice

    eggyspice Occasional commenter

    Indeed, on a personal level, I feel a bit sad for my next door neighbours but one, who run a small business and have purchased a property probably well above their expectations, as they have three primary school children and haven't realised the cost of bringing them into adulthood, never mind the horses and courses life can take.

    Still, you can't stop the arrogance of ignorance can you? And I dare say it transfers into the idea we can all "borrow form prosperity" today, just like the British Government has.
  4. eggyspice

    eggyspice Occasional commenter

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