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Endogenous asymmetric money illusion

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  • Duarte, Diogo
  • Saporito, Yuri F.

Abstract

We show that when investors suffer from endogenous asymmetric money illusion, the usual proportionality between money supply and nominal prices commonly present in frictionless economies is eliminated. This drives changes in the money supply to cause real price fluctuations. Nevertheless, the combined effect on the real state price density and the price of money leads the nominal state price density, and consequently nominal bond prices, to be independent of money illusion. This article thus provides a theoretical foundation for Modigliani-Cohn’s conjecture that money illusion impacts stock markets but not bond markets.

Suggested Citation

  • Duarte, Diogo & Saporito, Yuri F., 2019. "Endogenous asymmetric money illusion," Journal of Banking & Finance, Elsevier, vol. 109(C).
    • Handle: RePEc:eee:jbfina:v:109:y:2019:i:c:s0378426619302559
    DOI: 10.1016/j.jbankfin.2019.105681
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    More about this item

    Keywords

    Money illusion; Modigliani-Cohn hypothesis; Money superneutrality; Asset pricing;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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