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Perceived inflation under loss aversion

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  • Lena Dr䧥r
  • 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%.

Suggested Citation

  • Lena Dr䧥r & Jan-Oliver Menz & Ulrich Fritsche, 2014. "Perceived inflation under loss aversion," Applied Economics, Taylor & Francis Journals, vol. 46(3), pages 282-293, January.
  • Handle: RePEc:taf:applec:v:46:y:2014:i:3:p:282-293
    DOI: 10.1080/00036846.2013.844328
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    2. Ewa Stanisławska, 2019. "Consumers’ Perception of Inflation in Inflationary and Deflationary Environment," Journal of Business Cycle Research, Springer;Centre for International Research on Economic Tendency Surveys (CIRET), vol. 15(1), pages 41-71, April.
    3. Lamla, Michael J. & Lein, Sarah M., 2014. "The role of media for consumers’ inflation expectation formation," Journal of Economic Behavior & Organization, Elsevier, vol. 106(C), pages 62-77.
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    5. Peter, Eckley, 2015. "(Non)rationality of consumer inflation perceptions," MPRA Paper 77082, University Library of Munich, Germany.

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    More about this item

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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