We consider the effect of money illusion - defined referring to Stevens' ratio estimation function - on the long-run Phillips curve in an otherwise standard New Keynesian model of sticky wages. We show that if households under-perceive real economic variables, negative money non-superneutralities will become more severe. On the contrary, if households over-perceive real variables, positive money nonsuperneutralities will arise. We also provide a welfare analysis of our results and we show that they are robust to the inclusion of varying capital into the model. Firms' (over-)under-perception of the real prices of production inputs strengthens) weakens negative money non-superneutralities. In an appendix, we investigate how money illusion affects the short-run effects of a monetary shock.
Phillips curve inflation nominal inertia monetary policy dynamic general equilibrium money illusion Stevens' ratio estimation function