Misperceived Money and Inflation Dynamics∗

The baseline version of the new Keynesian (NK) model has important empirical limita-tions, in particular with regard to inflation, output and interest rate dynamics. Some of its recent extensions fare better empirically but only by relying on implausible pricing schemes. We offer an alternative approach that emphasizes informational imperfections regarding mon-etary aggregates. Monetary misperceptions give rise to a standard signal extraction problem that enables the NK model to exhibit inflation inertia, realistic inflation and output dynamics and a liquidity effect. Unlike previous work, we establish that misperceived money growth is quantitatively important and also matters significantly for economic activity