An Experimental Investigation of the Nominal and Real Effects of Fiat Currency Inflation

Abel Winn

Truland Building, Suite 400H
May 01, 2005, 08:00 PM to 07:00 PM


"The theory of money neutrality has been a hotly debated topic in the macroeconomic literature for well over half a century. Economists in the Keynesian school of thought have argued that forces such as money illusion and price stickiness will prevent the price level from fully adjusting to monetary shocks, thus allowing monetary policy to affect real economic variables such as GDP and unemployment. New Classical economists have pointed out that real economic changes due to nominal shocks will necessarily reduce the welfare of some economic agents. These individuals therefore have strong incentives to anticipate monetary policy and adjust their behavior so as to render it neutral. So long as agents have sufficient information, they argue, individuals with rational expectations will not systematically allow nominal variables to influence real ones. Austrian economists note that money always enters an economy via certain Iinjection points,O and that despite agentsI expectations, those individuals into whose hands the new money initially accumulates will spend it on the goods and services they prefer, bidding up their prices and expanding their production. As a result, monetary shocks will have real effects at the injection points, and these real effects will ripple out through the economy, gradually lessening in their impact. This dissertation empirically tests the above theories using experimental methods with human subjects. An eight agent, two good economy is constructed in a computer laboratory setting, and agents are allowed to exchange goods with each other using an experimental currency as the medium of exchange. Shocks to the money supply are introduced, and data on total output, output composition, relative price, and economic efficiency are gathered. We find that when agents are given no information on the monetary shocks, changes to the money supply affect total output when the money is proportionally distributed throughout the economy, while output composition and relative price is affected when the new money is initially given to only a subset of agents. When subjects are given perfect information on the money supply, proportionally distributed money is rendered essentially neutral, while money distributed to a subset of agents still affects the output composition. "

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