Nominal illusion

In order to better understand money illusion, it might help to consider some similar examples in other areas.  The Economist has an interesting story on the rare coin market:

The [rare coin] market’s wild-west days ended in 1986 when the first independent coin certifier, the Professional Coin Grading Service (PCGS), based in California, established itself as an authority on authenticity and quality. Grading each coin on a one to 70 scale, PCGS gave the market transparency, boosting investor confidence and sales volumes. Today, global sales of rare coins are estimated at $5bn-8bn a year, with 85% of the market in America. So important has third-party grading become that almost all rare coins sold at auction these days have been graded and sealed in stickered plastic by either PCGS or its main rival, Numismatic Guaranty Corporation (NGC), which is based in Florida.

Some blame the grading system itself for the eye-watering returns. Investors cling to the assigned grade: even a one-point boost can double or even triple a coin’s retail price. An 1884 silver dollar from the San Francisco mint, for instance, sells for $19,500 at the 62 grade but surges to $65,000 at 63.

The grading process is subjective: the evaluation criteria include “eye appeal”. Scott Travers, a coin dealer in New York, says investors sometimes resubmit the same coin ten or 20 times to the same company in hope of an upgrade. All this led to a steady “grade inflation”, that has been cheered along by investors. But in the long term, a sustained rise by simple fiat in the number of high-grade coins will surely depress prices. Already, a new type of “grader of graders” has emerged, hoping to instil some discipline by rating the consistency of the two primary graders. Next: graders of graders of graders?

This is, of course, another example of the sort of grade inflation that you see in American education.  What can we learn from this?

1. The incentive to inflate exists in both the private and public sectors.  I’ve heard that grade inflation is often worse in private schools, can anyone confirm?

2.  From a sociological perspective, the rare coin market is quite different from academia.  Whereas educators have a left wing bias, the rare coin world is more right wing.  So theories of academic grade inflation based on the left wing bias in education should be viewed with suspicion.

3.  In my view, monetary inflation, academic grade inflation, and rare coin grade inflation are partly motivated by what could be called “nominal illusion”, the tendency to see numbers as having the same meaning at two different points in time.  People wrongly assume that a dollar is a dollar, a 4.0 is a 4.0, and MS62 silver dollar is a MS62 silver dollar.

4.  In all three cases the illusion is only partial.  Workers feel better with a 10% raise during a period of 10% inflation, than a zero raise during zero inflation. That’s money illusion.  But they are not completely ignorant on this point.  They’d prefer an 8% raise with zero inflation to a 10% raise with 10% inflation.  Employers don’t know enough to completely look past the effects of grade inflation, which differ by college and by cohort, but they have some awareness that a 4.0 back a few decades is worth more than a 4.0 today.  And in the rare coin market, a coin that was graded MS62 a couple of decades ago has more value than one receiving that grade today.  If you look at rare coins on eBay, you’ll occasionally see references to the older form of packaging being used by the grading service, which makes the grade more desirable. It’s not just old coins that are more valuable; coins graded long ago are also more valuable.

5.  It’s possible that the incentive to inflate grades is greater than the incentive to inflate the money supply, because money is a government monopoly.  Think about the example of gasoline pricing in America.  Most consumers know that gas listed at 239.x a gallon is actually 239.9 a gallon, even though the 9 is so small that it’s hard to read.  Since almost all gas stations do this, any single station that did not would be at a competitive disadvantage.  My daughter told me that Berkeley does less grade inflation than other schools, perhaps because they are an elite government institution, with prices far below market.  They have a captive audience.  And government institutions have less entrepreneurial zeal. But I believe that most schools and most coin graders grade inflate because not doing so puts them at a competitive disadvantage.  I know that I inflated my grades over time because I wanted my student grades to be understood by employers, and I thought the best way of doing so was by grading under a similar set of criteria to other professors.  As they inflated, so did I.

6.  Contra Hayek, if we went to a system of competitive private monies, there is no reason to believe that issuers would keep the value of their currencies stable.



24 Responses to “Nominal illusion”

  1. Gravatar of Bob Bob
    18. June 2017 at 06:41

    The same problem occurs in large company performance reviews. It’s also a place where people have attempt to curb inflation by curbing, either at pretty small organizational units or at bigger ones. The end result of fighting this is well documented dysfunction: In the first way of curbing this, low performing workers are more valuable than high performing ones: A team with great people will lead to some of them leaving on their own, so you don’t want to group them together. In the second approach, grading becomes more of a factor of managerial influence than everything else.

    So it’s not just that problems like money illusion exists, but that mild inflation is probably the best way to deal with it than we have.

  2. Gravatar of Matthias Görgens Matthias Görgens
    18. June 2017 at 07:30

    Historic free banking and thus competitive note issue clung to a commodity standard, like gold. A modern free banking might choose even bitcoin, gold, or just some government issued fiat currency as its anchor. (I’d guess the exact choice would be path-dependent.)

    Selgin writes a lot about free banking. Yes, a completely unchained fiat system like Hayek suggests might be unrealistic: people would probably not take to it.

  3. Gravatar of Jerry Brown Jerry Brown
    18. June 2017 at 08:43

    In my economics blog ratings system “The Money Illusion” already comes out at or very near the top in many of the most important categories (tolerance of inane comments from people like me is one category but not the most important). So any inflation in the ratings can only hurt your relative position. I have been considering establishing a new top grade for your writings (this blog goes to eleven), but am concerned this would wreck the system maybe causing the equivalence of hyper-inflation in the grading system. Is this a reasonable concern? 🙂

  4. Gravatar of ssumner ssumner
    18. June 2017 at 08:55

    Bob, Good example.

    Matthias, Good points–isn’t bitcoin an unbacked fiat currency that is accepted, at least to some extent?

    Jerry, I’m fine with an 11 rating. 🙂

  5. Gravatar of G G
    18. June 2017 at 13:01

    I can add a personal anecdote to Bob’s comment about company performance reviews. My firm used to grade on a 1-5 scale, with 1 being the best. 3 was described as “achieving.” My old manager would give me 3’s and when I protested, he said that it was based on a curve to the entire firm, so how could I be a 2 or 1 compared to others who were way more experienced and productive than me, a guy just out of college? I accepted this until I saw others in my same year but working under different managers getting promoted faster than me. They did away with the grading scale last year. I’ve also had conversations with people at my experience level who are envious of me because they believe my current manager will fight harder for promotions for me than theirs will for them.

    Another example is with employee surveys. Every year each employee receives a list of survey questions and answers between 1 and 5, or between “strongly agree” and “strongly disagree.” Apparently my team scored below average than most teams (or a suppose more disagreeable than average), which reflected poorly on the head of my team. This led to several annoying team meetings with discussions about our feelings on things. My manager and I agreed that this year we’re just going to put down positive responses to avoid this next year.

    I’m four years out of school and a lot of my bright-eyed optimism for doing meaningful work is gone. I now view work more as a means to fund my interests and hobbies.

  6. Gravatar of David Pinto David Pinto
    18. June 2017 at 14:00

    I interview students for college. When I speak with students from local public and private schools, I see no difference in grading the best students are between 98 and 100 on a 100 point scale. When I speak to students from the elite boarding school in the area, I notice no grade inflation. The best students are between 90 and 94 on a 100 point scale. In fact, the first time I interviewed at the elite school, I made sure to ask that they were indeed tough graders, because the grades did not match my expectation for the obvious quality of the students.

  7. Gravatar of Major.Freedom Major.Freedom
    18. June 2017 at 14:36

    “The incentive to inflate exists in both the private and public sectors.”

    No that is *not* a takeaway from the rare coins example you cited.

    It is not true that the example you cited shows “an incentive to inflate in the private sector“.

    In the private sector it is the polar opposite. There is a tendency and incentive to *deflate* in the private sector.


    First you have to realise that in your example, the rise in price of the rare coins is in part a result of DOLLARS being inflated over time, which tends to raise the *US DOLLAR PRICE* of rare coins. The fact that more dollars are needed to purchase a rare coin of a given quality, is testament to the fact that the value of dollars is declining relative to the coins, which is to say the value of the coins is increasing, and are therefore “deflating” relative to dollars.

    Next, you have to realise that we cannot isolate the price of rare coins from everything else such that we make the fallacious conclusion of “well since the dollar price of rare coins is going up, this represents a case of the private sector “inflating”.” No, it doesn’t, because we have to consider the trade-off of nominal demands. If the nominal DOLLAR demand of rare coins goes up, then all else equal, this requires the nominal DOLLAR demand of everything else to go down. The only way it won’t do this, in a sustained manner, would be if the central bank prints more dollars such that the nominal demand for other goods not rare coins, doesn’t go down historically. But again, in this case, it would be a case of dollar inflation, not rare coin inflation.

    Next, the only way that the concept of inflation can apply to rare coins, would be if there is an incentive to raise the supply of rare coins over time. Well of course that is an incentive for producers and sellers, but that isn’t inflation. We don’t say that Toyota “has an incentive to inflate the supply of Toyota cars”. The actual incentive of profit making, tends to LOWER prices over time in a free market without a legalized counterfeiter printing dollars making everything more expensive over time, including labor with a time lag. A free market in money would almost certainly result in FEWER units of money being created relative to all other goods and services, which will put a continuous downward pressure on prices (and costs) such that they tend to fall over time.

    The incentive in a free market is to produce goods and services, and there is an incentive for money to be tight supply as well. People want to store exchange value if they live in a free market. This requires a commodity to be difficult to reproduce. And that is in fact what happened when there was no state monopoly forcing any commodity as money. Precious metals became money before any King ordered taxes in it, because gold retained its value as it could not be reproduced.

    Sumner, you took a historical event and twisted it and contorted it to fit your socialist worldview about money. Accuse the free market of having an incentive to inflate, that way your explicit defense and apologizing for central banks inflating, doesn’t seem so foreign to markets.

    You don’t fool me for one second.

  8. Gravatar of Major.Freedom Major.Freedom
    18. June 2017 at 14:46

    “Contra Hayek, if we went to a system of competitive private monies, there is no reason to believe that issuers would keep the value of their currencies stable.”

    Stop thinking like a socialist! For Pete’s sake. Privatization of money would NOT require or imply or even have any bearing from “issuers keeping the value of *their* currencies stable”. Privatizing money would be an activity that includes the valuations of INDIVIDUAL OWNERS of that commodity. Just because Toyota manufactures cars, that doesn’t mean Toyota suddenly acquires the duty or obligation to ensure that *their* supply of cars MUST be produced in a “stable” manner over time.

    The fake duty you would claim must be imposed on money issuers, as if they must prove to you that NGDPLT will remain intact first, is not at all their duty before they have a RIGHT to do it. Just like you believe cancer patients have a right to ingest marijuana if it makes them feel better. And not only that, but the less there is of this “imposing” duty on people, the more likely the outcome will be favorable, because the less centralized control there is over it all. With less centralized control, mistakes that are made would be localized, and not only that, but it would be legal for anyone to enter the market to “fix” the previous issue.

    You make it sound as if people are so stupid that they cannot learn from having made a poor choice for money issuance in a private setting. As if individuals MUST have a centralized authority over them telling them what money to use, what money to pay in taxes, which is exactly the socialist mentality.

    The reason why I keep calling you a socialist, is because you are one, and you think like one, when it comes to money.

  9. Gravatar of Lorenzo from Oz Lorenzo from Oz
    18. June 2017 at 16:01

    Thoughts are about reality, so it makes sense that there would be some inertia (nominal illusion — nice term) in our use of terms: especially quantitative measures.

    I remain a bit leery of dismissing it all as irrational, at least in the case of money illusion, since our bills and expenses are also in nominal terms — that is, some of it is inherent inertia in any system of monetised exchange.

    Though wage “stickiness” is not quite the same sort of inertia (though there may be some, varying, overlap), it is also a form of inertia in the system of exchange.

  10. Gravatar of Steve Steve
    18. June 2017 at 19:07

    The rare coin market is actually fairly efficient, albeit with transactional frictions on true rarities.

    Most people prefer old slabs over new slabs at the same grade, but are also aware of regrades, so they also prefer freshness (implying no regrades) as well as provenance. Old slabs that aren’t fresh are sometimes viewed with as much suspicion as regrades.

    Likewise, there are plenty of coins with 4x or 5x price difference at the same grade, because one agency is less trusted than the other. So grade inflation can inflict long-term reputational damage.

    Grading is better thought of as something with a 1 point error bar; you would prefer the median grade rather than the best grade in multiple attempts, and you would also prefer a expert appraisal on higher end stuff. Most pricing anomalies reflect this. Sort of like using a kid’s median SAT score instead of the best result in 10 tries.

    Finally, there are many price indexes for rare coins. A huge percentage of the market is marginally rare gold coins, so many prices simply track gold plus a premium. Many coins have actually lost value since the late 1980s, as the initial bubble in wall st packaging of certified common coins is still deflating. However truly rare coins have been skyrocketing in value, trading more like Monets. The same dynamic affects art, with true cultural rarities going nuts, while temporary fashions fall out of favor. The reference index you choose to use says more than the price performance.

  11. Gravatar of Benjamin Cole Benjamin Cole
    18. June 2017 at 19:52

    I sometimes think there are no “bubbles” except in certain categories, such as rare art, gold and collectibles (including rare coins and stamps).

    The value of the above goods is social. The power generation today, for example, loves Andy Warhol. Warhol is cool to people coming into money now. I like some of Warhol’s work, but I would guess he will fade as people who regard him highly die off. The art-business community will attempt sophisticated marketing to maintain Warhol’s value and that sometimes is effective.

    Coins and gold have shown some resiliency, but there was a time in China when gold was regarded as gaudy, vulgar, for jewelry, baubles and fops. Silver was the monetary metal, and indeed China banks are called “silver houses” to this day.

    So, maybe gold will become brothel-guilding again, while silver reigns high!

    Funny question: Gold hit $1,800 or so several years back, and then sank to $1,200, never to recover. Why were there no “gold bubble” mongers? Why does no one say, “Gold was in a bubble that popped.”

    Q of the day: When cities zone property to create scarcity, that seems to fly. No outrage from the pinnacles of righteousness etc.

    When cities boost the minimum wage, that is Satanic.

    So…should cities zone for labor instead? That is, only X million people are permitted to work in Los Angeles? They have medallions like NYC cab drivers?

    “I can’t hire you unless you have a worker medallion. That is the law.”

    The resulting labor scarcity should boost wages, just as property zoning and scarcity boosts rents.

  12. Gravatar of Benjamin Cole Benjamin Cole
    19. June 2017 at 01:23


    “Korea tightens rules on housing to restrain buying frenzy in some cities

    SEOUL (Reuters) — South Korea on Monday announced tighter mortgage rules and curbs on speculative resales of homes in Seoul and parts of Busan — the toughest rules in almost three years as policymakers sought to stabilize hot housing markets amid soaring household debt.

    The latest steps are an extension of curbs announced in November 2016, when the government started turning the screws on speculative housing investments amid concerns a worrying build-up in household debt could leave the economy exposed to a crash.”


    Gee, Tokyo does not have this problem. Tokyo has “loose” zoning, that is people can actually building housing to satisfy the market.

    Next, Korean monetary authorities will ponder the money supply….

  13. Gravatar of Benjamin Cole Benjamin Cole
    19. June 2017 at 01:31


    Japanese bank deposits top $9.5tn
    Swelling balances reflect the sluggish economy, with nowhere for money to go

    KOJI OKUDA, Nikkei staff writer
    TOKYO — The balance of deposits at financial institutions in Japan is swelling, leaving capital that could be used as the primary source for bank loans piled up as dead money.

    As of the end of March, the balance of deposits at Japan’s banks and credit unions came to a record 1,053 trillion yen ($9.55 trillion). Elderly customers have continued to deposit their retirement allowances and pensions, though their deposits bear practically no interest due to the Bank of Japan’s negative interest rate policy.

  14. Gravatar of Anand Anand
    19. June 2017 at 03:03

    Some thoughts on your last post about “Canadian Taliban”. I am not sure if this analysis is correct, but anyway.

    Imo, the heading of the post, and the post itself is really weird. The Taliban do not organize petitions or protests; they use their state power to force their view through. Organizing petitions or protests, or shaming people on Twitter is about as prototypical a case of “free speech” and “libertarianism” as you can get.

    To take one example: the rights to the “Scaffold” installation was voluntarily transferred by the artists to representatives of some group. The people who now own the painting decided to destroy it. Now, why did the artist do that? It was not because of state coercion. If you are cynical, you can call the whole thing public relations or “reputation management”. A lot of the value in these kinds of art are because of good press/a progressive image and so on. Reputation management is as “libertarian” an idea you can get.

    The idea of cultural appropriation itself is rather silly, but the post seems confused to me. In a “libertarian” world, savvy people would discount the opinions of the people who they find silly. The shaming tactics themselves would still exist; indeed, they are crucial to the whole thing. Because if you have no government regulations, reputation becomes key to making the whole thing work; look at movie critic reviews or Yelp ratings. Petitions/shaming campaigns are a very old and time-tested way of hurting reputations.

    Now, there is private power and there is government power; both can be oppressive. But if we want to go into issues of private power, then the discussion should be much broader.

  15. Gravatar of George Selgin George Selgin
    19. June 2017 at 04:16

    “Contra Hayek, if we went to a system of competitive private monies, there is no reason to believe that issuers would keep the value of their currencies stable.” I quite agree with this, Scott, and have made the point myself. But in my opinion Hayek’s error consisted of his understanding that monies of stable purchasing power would be considered, not merely publicly optimal (itself a stance you and I question), but privately so. But what’s privately optimal, which I believe would determine the relevant reputation-based equilibrium in a system of competing money issuers, isn’t inflation but _deflation_. Consumers would, in other words, tend to favor private monies that appreciate over ones that merely maintain (or lose) value.

    This seems, indeed, to be what has been happening in the crypto-currency market. The problem, of course, is that a rapidly appreciating “money” in the loose sense of the term turns out not to be a very desirable or practical “money” in the strict sense, that is, a good generally acceptable medium of exchange.

    All this is apart from the quite separate problem with Hayek’s scheme, addressed very well in Larry White’s chapter on competing fiat monies (in The Theory of Monetary Institutions) that the globally optimal equilibrium in a system of competing fiat suppliers might actually be one involving rapid, confiscatory hyperinflation, which in practice means that, offered the opportunity to trust a private fiat money issuers’ promise to provide them with either stable value or appreciating fiat money, people will just say, “no thanks!”

  16. Gravatar of Benjamin Cole Benjamin Cole
    19. June 2017 at 04:45

    George Selgin:

    1. In the last 40 years, the world’s central banks have certainly proven they can deliver “stable” inflation rates, or possibly even deflation.

    Should the discussion now turn to what monetary regimes would best promote growth? How many more decades do we want to go on framing monetary discussions with inflation, instead of growth?

    2. What if 3% inflation (CPI) is the level of inflation that best promotes growth (this is a rough empirical observation from 1982 to 2007). Could private bankers gin up 3% inflation, or is that a target that could only be hit through central banking?

    3. If inflation rates are so vital, why were real growth rates higher in the U.S. Japan and China when inflation rates were both higher and more erratic?

  17. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    19. June 2017 at 07:02

    Maybe it’s time to inflate the grades of President Trump;

    He has appointed unflinching conservatives to posts where most Republican presidents flinch, such as the Environmental Protection Agency and the Food and Drug Administration. He is fulfilling his pledge to appoint conservative judges.

    He has been fearless in rolling back the regulatory state, in cooperation with Republicans in Congress.

    There is a tension in Trump’s foreign policy. He clearly still harbors the belief that the United States is overextended and other countries are free-loading. I think he’s right.

    But most conservatives believe in maintaining the U.S. role as the guarantor of an international rules-based order, and Trump has appointed a national security and foreign policy team that sees the world that way as well.

    Uncharacteristically, Trump has actually removed uncertainty regarding the domestic economy. Whether he and the GOP Congress can enact tax, health care or financial market reforms is unknown. But at least economic actors can believe that things won’t get worse during a Trump presidency on regulation and taxation. That’s an underappreciated big deal.

    There is also tension in Trump’s trade policies, but the fear that he would be a bull in a china shop has abated.

    From a conservative perspective, things couldn’t get better during the first five months of the president who succeeded Barack Obama.

  18. Gravatar of Randomize Randomize
    19. June 2017 at 09:06

    Grade inflation was particularly bad at my wife’s school, a small cohort-based not-for-profit.

    The administration was dealing with a couple factors:

    1. Not-for-profit didn’t mean that they were agnostic to enrollment. Full chairs paid more than empty ones so they were reluctant to kick students out in general.

    2. Even worse, enough students dropped out that the cohort would have been cancelled entirely if they lost one more student in its last semester. This meant that they kept students strung along who simply had no business being there (repeated failed state certification tests, for example). In addition to the grade inflation, this meant a handful of students who had no chance at getting jobs in their field but were saddled with all the debt anyway.

    All this meant that the school had to grade so that the worst student in the class would receive a C and those who even put in a marginal amount of effort subsequently received A’s. For my wife, who has a strong work ethic, it was very frustrating.

  19. Gravatar of Saturos Saturos
    19. June 2017 at 09:07

    Interesting new form of “open mouth operations” from the RBA:

  20. Gravatar of John Hall John Hall
    19. June 2017 at 10:24

    The nerd in me was like, “eye factor, I bet we can quantify that with computer vision and machine learning algorithms.”

  21. Gravatar of mbka mbka
    20. June 2017 at 00:21

    Similarly to David Pinto, I notice another kind of inflation. Students generally get so much better that I have trouble finding meaningful differences between the 50% that are already very, very good. But the curve doesn’t allow to gove 50% A’s . So the problem is a compression of the variance, and here, curving doesn’t help: curving only shifts the average up and down, it can’t widen the variance.
    Interpretation: markets are efficient because the demanded quality is improving up to the point of “uniformly good”. (allowing for a lot of hand waving of course, YMMV etc).

  22. Gravatar of George George
    20. June 2017 at 08:47


    could you please write a post about possible inflation stickiness and inflation patterns we have seen across the developed world since 2008? I.e. during the early part of the global recession, inflation was slow to drop and only turned into mild deflation. And I don’t think commodity shock in 2007/8 can explain it. E.g. in case of Greece one would expect Great Depression like deflation which never materialized. Now it seems we are seeing the opposite effect, inflation is very slow to rise even in places where labour markets look quite overheated.

    Secondly, inflation across Euro area is exhibiting very weird behaviour, especially once you check for unemployment and output gaps. Places with record low unemployment have still very little inflation and south experienced quite a notable spike in inflation this year despite having millions of unemployed people (above pre-crisis levels).
    I would just love to read your take on it and it is a pretty interesting research topic as well!


  23. Gravatar of Doug M Doug M
    20. June 2017 at 12:46

    Regarding grade inflation a few thoughts come to mind.

    I am told that the academic culture in France is that no one gets a 20/20, outside of perhaps a math exam. 20/20 on a writing assignment would suggest a perfect paper, and a perfect paper does not exist.

    Similarly, at my employer, no one gets 5/5 on a performance evaluation as that would suggest no room to improve.

    Regarding grade inflation in private schools (25 years ago). I went to a private prep school, and the college adviser told me on my university applications to mark up my transcripts from the assigned grades to what he thought the grade would have been had I been in a public school. And, to mark some number of courses as “honors” courses.

  24. Gravatar of Scott Sumner Scott Sumner
    21. June 2017 at 05:50

    G, Interesting.

    David, Thanks for that info.

    Lorenzo, Nominal debt may explain a bit of sticky wages, but not all of it.

    Steve, Thanks for that info. Interesting.

    Anand, I addressed that in my previous comment section.

    George, Good points. I would just add that Bitcoin is even worse as a medium of account than a medium of exchange. I could imagine paying for something using Bitcoin; I could not imagine a long term labor contract denominated in Bitcoin.

    Patrick, That ignores the areas of increased regulation—travel to Cuba, immigration, marijuana, etc.

    He’s also ignoring areas that need regulation–such as the environment.

    Randomize, That’s a very common problem.

    Saturos. Not from the Onion?

    mbka, I think it depends where you teach.

    George, Good questions. Part of it is institutional—prices are stickier in Greece than Hong Kong. The Mediterranean countries have a high natural rate of unemployment, but even that doesn’t explain the recent inflation uptick you cited. I’ll see what I can find out about the issue.

    Doug. People almost never got a grade of 100 on my monetary economics exams.

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