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Perceived Inflation under Loss Aversion

Dräger Lena (), Jan-Oliver Menz () and Ulrich Fritsche ()
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Dräger Lena: University of Hamburg

Authors registered in the RePEc Author Service: Lena Dräger ()

No 201105, Macroeconomics and Finance Series from University of Hamburg, Department of Socioeconomics

Abstract: Building on Prospect Theory, we apply the concept of loss aversion to the formation of inflation perceptions and test empirically for non- linearities 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 non-linearities in the inflation perception formation 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%.

Keywords: Inflation Perceptions; Loss Aversion; Panel Smooth Tran- sition Models; Dynamic Panel. (search for similar items in EconPapers)
JEL-codes: C33 D81 D82 E31 (search for similar items in EconPapers)
Date: 2011-05
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Journal Article: Perceived inflation under loss aversion (2014) Downloads
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