On the Welfare Costs of Perceptions Biases

Hugh Montag

No 535, Economic Working Papers from Bureau of Labor Statistics

Abstract: Are households significantly harmed by inaccurate beliefs about inflation? This paper analyzes two established inflation perceptions biases and evaluates their welfare effects. The first bias is the frequency bias, where households overweight goods that they purchase frequently but are a small share of their consumption basket. In my French sample, I find that households fixate on bread prices. The second bias is that households consistently overestimate the current inflation rate, which I call the level bias in this paper. I estimate the magnitude of these biases using a confidential French household survey. To evaluate the welfare losses of the two biases, I incorporate biased inflation perceptions into a partial-equilibrium model where households save in a single nominal bond subject to inflation risk. The level bias significantly reduces welfare and asset accumulation, while the frequency bias has negligible effects. The welfare loss shrinks if I remove the perceptions bias while keeping the expectations bias, which suggest that inaccurate perceptions can harm households beyond the effect on forecasts.

Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:bls:wpaper:535

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