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Perceived inflation under loss aversion

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  • Lena Dräger
  • Jan-Oliver Menz
  • Ulrich Fritsche

Abstract

Building on prospect theory, we apply the concept of loss aversion to the formation of inflation perceptions and test empirically for nonlinearities in the inflation-perceptions relation for a panel of 10 Euro area countries. Specifically, under the assumption of loss aversion, inflation changes above a certain reference rate will be perceived more strongly. Rejecting rationality of inflation perceptions in general under symmetric loss and in a majority of cases under flexible loss functions, panel smooth transition models give evidence of nonlinearities in the inflation-perceptions relation regarding both actual inflation and time. This result is confirmed by dynamic fixed effects estimates, where the slope of the estimated value function is significantly steeper in the loss region and the implied average reference inflation rate is found close to 2%.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Economics.

Volume (Year): 46 (2014)
Issue (Month): 3 (January)
Pages: 282-293

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Handle: RePEc:taf:applec:v:46:y:2014:i:3:p:282-293

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Cited by:
  1. Enkelmann, Sören & Berlemann, Michael & Kuhlenkasper, Torben, 2013. "Unraveling the Relationship between Presidential Approval and the Economy - A Multi-Dimensional Semi-Parametric Approach," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79836, Verein für Socialpolitik / German Economic Association.

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