Non-linear dynamics of inflation aversion in the Euro Area: Evidence from a Panel Smooth Transition model

This paper investigates how inflation and unemployment influence households’ inflation aversion. Existing literature documents significant cross-country heterogeneity in aversion, but offers little insights into how this behavior unfolds within a monetary union. Using Eurobarometer data from 12 Euro Area countries and applying a Panel Smooth Transition Regression (PSTR) framework, this paper contributes new evidence on the dynamics of inflation aversion across countries under the same monetary policy. The central intuition is that aversion is shaped by inflation and unemployment, but its strength depends on whether these variables are in low or high regimes. I show that countries with low average inflation exhibit strong aversion only once inflation enters the high regime, whereas countries with high average inflation display aversion even in the low regime, which intensifies further in the high regime. Consequently, the response of aversion to inflation is heterogeneous: inelastic for most below-average inflation countries and elastic for most above-average ones. These findings broaden our understanding of aversion for inflation within a monetary union.