Perceptual noise and perceived inflation after the Euro currency changeover

Following the Euro changeover in January 2002, Euro Area consumers perceived an increase in inflation of striking magnitude and persistence, despite low and stable recorded inflation. We offer a behavioural analysis that rationalises this apparent economic illusion. We propose that the changeover induced perceptual noise that increased consumers' uncertainty when assessing transaction surpluses, leading them to experience reduced value for money in the marketplace. This perceptual noise theory is consistent with the timing and persistence of the illusion. It predicts a positive relationship between overestimation of inflation and a contemporaneous measure of consumers' subjective difficulty using the new currency, which we confirm using panel data for Euro Area countries. The theory also implies a simultaneous downward shift in expected inflation, which we also confirm. The analysis has implications for models of household decision-making, assumptions of rationality in economic theory and policy surrounding currency changeovers. (C) 2015 Elsevier B.V. All rights reserved.