Perceptual Noise and Perceived Inflation after the Euro Currency Changeover

September 30, 2015 | Journal Article

Authors: Pete Lunn , David Duffy
Journal of Behavioral and Experimental Finance , Vol. 7 , September, 2015 , pp. 1-16

Following the Euro changeover in January 2002, Euro Area consumers perceived an increase in inflation of striking magnitude and persistence, despite low and stable recorded inflation. We offer a behavioural analysis that rationalises this apparent economic illusion. We propose that the changeover induced perceptual noise that increased consumers’ uncertainty when assessing transaction surpluses, leading them to experience reduced value for money in the marketplace. This perceptual noise theory is consistent with the timing and persistence of the illusion. It predicts a positive relationship between overestimation of inflation and a contemporaneous measure of consumers’ subjective difficulty using the new currency, which we confirm using panel data for Euro Area countries. The theory also implies a simultaneous downward shift in expected inflation, which we also confirm. The analysis has implications for models of household decision-making, assumptions of rationality in economic theory and policy surrounding currency changeovers.

  • Publication Details

    Journal Article

    ESRI Series Number: 201554
    Research Area: Behavioural Economics
    Date of Publication: September 30, 2015
    Published Online: May 11, 2015
    Publisher: Elsevier
    View External Link

© 2015 The Economic and Social Research Institute. All rights reserved. Website by JET Design