On the Consistency of Money Illusion in New Keynesian Models

Kengo Nutahara

No 26-009E, CIGS Working Paper Series from The Canon Institute for Global Studies

Abstract: 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.

Pages: 10
Date: 2026-07
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