Households' Inflation Expectations and Consumption in Macroeconomic Models: A Negative Real Income Channel

While the standard New Keynesian model implies that higher households' inflation expectations strongly raise nominal wage expectations and generate a positive consumption response, empirical evidence shows low passthrough to nominal wage expectations and a mixed sign of the consumption response. I study representative agent and heterogeneous agent New Keynesian models that allow for this low passthrough, arising from myopic nominal wage expectations. In the representative agent model, consumption still increases because households receive profits that offset the expected decline in real wages. In contrast, in the heterogeneous agent model, the consumption response becomes negative when the profit channel is weakened and the disconnect between inflation and nominal wage expectations is sufficiently strong.