Working Paper（26-009E）On the Consistency of Money Illusion in New Keynesian Models

This paper compares alternative ways of modeling money illusion in New Keynesian frameworks. We examine nominal consumption in utility, real-wage misperception, and inflation misperception under labor-augmenting technological growth. The first two approaches generally introduce direct dependence on the price level or require additional preference normalizations to preserve the benchmark balanced-growth path. Modeling money illusion as misperception of current and expected inflation preserves the standard growth structure while generating wedges in labor supply and intertemporal demand. Inflation misperception provides a tractable benchmark for future quantitative macroeconomic analysis.

Keywords: Money Illusion; Inflation misperceptions; New Keynesian models

JEL Classifications: E31, D84