Discussion Paper, No. 24 - June 14, 2011

Discussion Paper No. 24 June 14, 2011

Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000.

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Legally responsible publisher: Cecilia Hermansson, +46-8-5859 1588.

Annika Paabut, +372 6 135 440. Elina Allikalt, +372 6 131 989.

Perceived inflation after euro cash changeover: the case of EstoniaThe adoption of euro has been accompanied by a larger increase in inflation perceptions than actual inflation developments. The wedge between those two has widened right after the adoption of euro in all euro area countries. On one hand, the explanation of the gap between actual and perceived inflation is related to the measuring of those rates – the indices reflect price changes differently. On the other hand, there is a bulk of ideas and theories related to the consumers’ ability to adapt new value of exchange: the attitude towards new currency, the role of conversion rates, and the divergence of consumer baskets just to name a few.

In this paper we analyse price movements in time of the shock – adoption of new currency. We start by explaining the overall price changes and then turn to the price change after a shock like change in value of exchange occurs. In the literature prices tend to be rather sticky during the stable economic development – the changes in prices occur only once a year on average. The currency changeover might influence the price level via costs – firms are facing different costs during the currency changeover, like the need to change price tags, related IT costs, the need to have an extra amount of cash during the time of the parallel circulation etc. The transfer of these costs into the consumer prices depends on the firms’ pricing strategies as well as on the overall competition level in the sector. In addition, price changes may stem from the marketing strategies (for instance, psychological pricing).

Even though the prices may be calculated correctly people tend to perceive higher pricescompared to those in the national currency. In this paper we analyse different psychological factors that influence the perception of prices, like the way people learn, memorise or identify themselves or how they feel about the new currency. People tend, for example, calculate prices in euros back into national currency although the new currency has been in circulation for some time. The comparison with prices in national currency that was valid more than six months ago may be one of the causes behind the wedge between the actual and perceived inflation.

In the empirical analysis we use data on euro area and EU countries and add some non-euro area countries as a control group. We find the relationship between actual and perceived infla-tion to be stationary before 2002 (the first wave of euro adoption), which indicates that people tend to perceive price changes rationally. After euro adoption the picture changed somewhat. The gap persisted until 2008 when both started to move similarly again in most countries. We conclude that the gap between perceived and actual inflation persisted for some years and within time disappeared again. We also analyse the causality between actual and perceived inflation rate using Granger causality test. The tests however will not show the magnitude or direction of the influence that people’s perceptions may have on actual and/or expected infla-tion, but show how much information one variable has to explain the other. Test results show that the changes in perceived inflation may explain the changes in actual inflation in only few countries (Ireland, the Netherlands, Sweden, and Slovenia). At the same time, we find strong

2 Discussion Paper No.24 June 14, 2011

relationship between perceived and expected inflation in Estonia, which might indicate the in-direct relationship between perceptions and actual rate of change of prices.

Annika PaabutActing Chief Economist at Swedbank Estonia

Contents: Page:

1. Introduction 3

2. Price changes before and after euro cash changeover: price do change... 4

3. The presence of a shock: how does euro cash changeover affect prices? 6

4. Inflation perception - psychological factors behind it 8

5. Inflation perception, expectations, and actual inflation in euro area countries after

euro adoption 13

6. What will it be for Estonia? Short discussion of the Estonian case 17

7. Conclusion 18

Discussion Paper No. 24 June 14, 2011 3

1. Introduction

In modern economic theory, the role of information has been central in de-scribing factors behind aggregate fluctuations and business cycles. This is especially pronounced after Lucas’s (1973) work on anticipated and unan-ticipated shocks, after which it was widely accepted that information process-ing influences expectations formation at the individual level and thus affects the aggregate level as well. In recent years, the discussion on inflation ex-pectations and inflation perception has been widespread and has focused on inflation perceptions after a currency changeover. In many cases, the euro cash changeover is associated with the so-called nimbus of price increase, and therefore it is thought that it might undermine the credibility of official price measures and/or adversely influence public opinion about the new cur-rency. In addition, perceived inflation may have real effects. For example, if consumers’ overestimation of inflation results in an underestimation of their purchasing power, this might cause suboptimal consumption decisions.1 Stix (2006) shows that many results of experimental studies support this hy-pothesis, indicating that, if consumers feel that prices have grown, they will cut back on consumption. In addition, perception may carry over to expecta-tions. The experience of Austria2 shows that, until the end of 1999, inflation expectations were slightly lower than perceived inflation; from 2000 to 2002, both rates were almost identical. However, the picture changed after Austria adopted the euro in 2002. Perceived inflation was approximately 1.5 per-centage points higher on average until 2003, after which expected inflation was revised significantly upwards (both expected and perceived inflations were brought together).

In economic theory, inflation expectations have an important role to play. Ac-cording to Phelps’s and Friedman’s work on the augmented Phillips curve, expected inflation is one of the most important determinants of actual infla-tion.3 Friedman (1968) said that the Phillips curve relationship is valid only in short run - in the long run economic agents will take inflation into account. That means that the wages will increase in accordance with anticipated infla-tion. So, he states that in the long run the relationship between inflation and unemployment disappears. More recent studies on Phillips curve (see for in-stance Clarida et al (1999) and Blanchard and Gali (2007)) are related to the New Keynesian dynamic stochastic general equilibrium models, where the prices are assumed to be sticky. Like the expectations augmented Phillips curve, the New Keynesian framework also states that the relationship be-tween inflation and unemployment is temporary and increased inflation may reduce unemployment only in the short run, but not permanently.

Real business cycle theory says that, according to the theory of the natural rate, the magnitude of a change in actual inflation is determined by the ex-pected inflation rate. And therefore, in the case of perfectly rational expecta-tions and without systemic forecasting errors, only unanticipated changes in inflation will affect real variables like output and unemployment.

Many papers have found that the wedge between perceived and actual price changes has widened in the euro area, especially after the introduction of euro banknotes and coins; at the same time, the newest papers show that in nonexceptional circumstances people perceive inflation rationally and their perceptions and expectations become exaggerated in the case of shock

1 ECB (2002), „Recent Developments in Consumer Inflation Perception“, Monthly Bulletin, July; pp 18-19.

2 Fluch & Stix (2005).

3 For details see Friedman (1968), Phelps (1967).

The way people perceive inflation may have real effects

Expectations play impor-tant role in economic theory


(e.g., currency changeover).4 In sum, one may divide the relevant literature into three groups. The first group deals with consumers’ perception of prices of the most frequently purchased goods and services.5 The second group of papers examines the individuals’ reaction to price increases and decreases – according to the hypothesis, people react more to price increases than de-creases.6 And the third group of papers7 studies experimental psychology, i.e., mechanisms that may influence people’s inflation perceptions after euro adoption.

Inflation perceptions, expectations and actual inflation in euro area (EA12)

-1%

0%

1%

2%

3%

4%

5%

-20

0

20

40

60

80

100

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Perceived inflation (r.s.)Expected inflation (r.s.)Actual inflation (HICP, l.s.)

Source: ECFIN, Eurostat

In this paper, we first briefly discuss the reasons why prices change during a currency changeover. The third chapter deals with inflation perception and the psychological factors behind it during euro adoption. Then we discuss price perception, expectations and actual inflation after euro cash change-over in euro area countries (the analysis covers period from 1997 (or later depending on the data availability) till 2010). And we conclude with a short discussion on the Estonian case. As Estonia has adopted the euro only quite recently (in January 2011), we do not have enough data for a deep analysis of cash changeover effects on inflation and inflation perception in Estonia.

2. Price changes before and after euro cash changeover: prices do change... As Taylor (1999) points out, prices of final goods in customer markets seem to be more responsive to changes in the costs of intermediate inputs to pro-duction than they are to changes in demand. Or, put differently, changes in costs seem to be more the reason that prices change than changes in markups. However, even in so-called customer markets, prices can change quite rapidly – for, instance, the price of an airline ticket changes on a day-to-day basis, and some of the tickets are even auctioned on the Internet. At the same time, some other prices stay at the same level for years.

4 Jemec (2010).

5 See Brachinger (2006), Stix (2006)

6 See, for instance, Del Giovane and Sabbatini’s (2005) study for Italy; Deutsche Bundesbank (2004) for Germany;, and Banque Nationale de Belgique (2002)

for Belgium.

7 See, for instance, Marques and Dehaene (2004), Traut-Mattausch et al. (2004).

Price changes stem for different reasons


According to Cecchetti (1985, 1986), the average time between price changes of magazines in the US was approximately 7 years, during rela-tively low inflation in the 1950s, and 3 years, during the era of relatively high inflation in the 1970s.8 Carlton (1986) analysed manufacturing firms in the US and found that the time between price changes varies from 1½ years for steel and chemicals to ½ year for plywood and nonferrous metals. This means that pricing behaviour differs among industries. Blinder (1994) and Blinder et al 1998) confirm the findings of Carlton (1989) and Cecchetti (1986). In his work, Blinder (1994) found that the time between price adjust-ments is one year: approximately 40% of firms change their prices once per year, 10% change prices more frequently than once per year, and the re-maining 50% leave their prices unchanged for more than a year.

In the more recent study of Bils and Klenow (2004), the results differ sub-stantially – they find much more frequent price changes, with half of the prices lasting only 4.3 months; if they exclude temporary price cuts (sales), they find that half of the prices last 5.5 months or less. Another important implication of their work is that the frequency of price changes differs dramatically across goods (their study covers 350 categories of goods and services, which is about 70 percent of consumer spending and was based on unpublished data from the Bureau of Labour Statistics for 1995-1997). For instance, some prices seldom change: prices of newspapers, men’s haircuts, and taxi fares change in fewer than 5% of the months covered. But, at the same time, some prices change very frequently, with prices of gasoline, tomatoes, and air fares changing in more than 70 % of the months.9

According to Cecchetti (1986), who studied newsstand prices of 38 Ameri-can magazines over 1953-1979, the time between price changes varied from 1.8 to 14 years. However, Bils and Klenow (2004) find that magazines (including subscription as well as newsstand prices) exhibit price changes on average every 11 months. And, more important, magazines prices are at the stickiest end of the spectrum, i.e., 86% of nonhousing goods prices change more frequently.10

The other branch of rather sticky prices is the prices of meals in restaurants. According to different studies,11 restaurant prices are the stickiest. But, in the case of shocks (such as the euro cash changeover) these prices tend to increase more than in other sectors, since entrepreneurs will try at least some time to postpone the price increase.

The pricing behaviour of Estonian enterprises is quite similar to the price-setting behaviour of entrepreneurs in the euro area: on average, Estonian entrepreneurs change the prices of their main product/service once per year.12

Recall from university economics lectures – prices do change and the change is affected by different factors. For instance, if prices of inputs increase, then there is a high probability that prices of final goods/services will increase as well. In addition, changes in prices are influenced by macroeconomic conditions, sectoral conditions (cost structure or degree of competition), time factors (like seasonality), and specific shocks (like value-added tax (VAT) changes, euro cash changeover, etc).

8 As we can see down the line, the group of goods analysed by Cecchetti can affect this result.

9 Bils and Klenow (2004).

10 Bils and Klenow (2004), p 954.

11 See, for instance, Hobijn et al (2004); Gaiotti and Lippi (2005), Bils and Klenow (2004), etc.

12 Randveer and Dabušinskas (2006).


3. The presence of a shock: how does euro cash change-over affect prices?Another important question is how often and whether these changes in input prices, macroeconomic conditions, etc. will affect pricing behaviour of firms. In the relevant literature, it has been found that the speed of this adjustment is to a large extent determined by the beliefs of the entrepreneurs – if entrepreneurs believe that the change in input prices is temporary, and then the price of their product will not change. But what about price changes in case of the shocks like a currency changeover? According to Eurostat (2003) approximately 50% of goods prices followed the usual path of change in 2001-2002, 20% of goods prices increased mostly due to other factors (e.g., tax changes, bad weather conditions, which ended up as poor har-vests in those years, etc.). The euro cash changeover in 2002 probably had an impact on the prices of approximately 26% of goods groups.13 The price increase was most apparent in the case of restaurants and cafés, and hairdressers and beauty parlours, i.e., mainly locally provided services.

Price increases in euro area (EA12) by different goods groups

0%

2%

4%

6%

8%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

alcohol and tobaccofoodhairdresserHICPrestaurants and cafesnewspapers, books

Source: Eurostat

There are several reasons why a slight price increase accompanies the cur-rency changeover; they mostly depend on how well an average company can manage expenses arising from the changeover.

From economic theory, we know that in the case of perfect competition, where the price equals marginal cost, fixed costs would not affect prices at all. On the other hand, where the company’s pricing strategy rests on ex-penses, prices may temporarily increase. After writing off the expenses, the company should return to the previous price level. Other countries’ experi-ence shows that the related extent of the price increase depends on the strength of competition in trade. The price increase appeared to be smaller in smaller shops and in those countries where retail trade concentration was lower. A temporary price pressure may follow, depending upon the firms’ pricing strategies, but there is no reason for prices to rise in the long run.

The main expenses that retail companies must defray due to the euro cash changeover are tied to price developments and replacement of price tags, training of employees, accounting in several currencies during the period of parallel circulation, and, when necessary, purchases of new software.14

13 See also Lättemäe (2005).

14 Lättemäe (2005).

Change in value of ex-change may have had effect on prices

Price changes depend on the level of competi-tion and firms pricing strategy

There are fixed one-time costs related to the change in currency


In addition to the one-off costs, there are factors that may give rise to one-off or permanent increase in prices. The main reasons for a temporary price in-crease in case of the currency changeover are menu costs, money illusion, other expenses directly related to the changeover, and psychological pricing.

Menu costs are defined as costs directly related to the price change process, such as, in the case of currency changeover, the development of new prices, printing of price tags, and remuneration of extra working hours etc. As men-tioned above, many firms change prices more often than once a year, but a regular price change might be postponed and timed for the changeover pe-riod. Thus, the menu costs directly related to the changeover in fact should decrease costs for the firm, but consumers perceive this as a price change due to the currency change. Such a pricing strategy is definitely trickier to implement when the media and public at large take more interest in the price changes.

Money illusion is a bias in the assessment of the real value of transactions, induced by their nominal representations.15 In other words, money illusion describes the phenomenon that people tend to observe nominal values, since the nominal value of money is salient and a natural unit: the price is low, when the nominal value of the good is low. Furthermore, money illusion influences international trade and tourism, or, as Fisher (1928) said: “almost everyone is subject to the ‘money illusion’ in respect to his own country’s currency. This seems to him to be stationary while the money of other coun-tries seems to change”16

There are also other expenses directly related to the euro cash changeover that retail companies and services providers bear additionally to direct costs. One may point to IT costs as one of the largest expense items. For instance, during the period of parallel circulation, software should be developed to al-low accounting in two currencies. The impact of this kind of costs transfer to the prices of goods/services will depend on the strategy firms use – if firm wants to depreciate the costs within a very short time period, the prices might increase in the short run, but if the software development is counted as long-term investment, then its effect on prices is almost negligible. At the same time, additional costs may arise from the need to hold a larger supply of cash because enterprises are directly involved in the withdrawal of cur-rency from circulation during the period of parallel circulation.17 This, in turn, increases the running operating costs over a short period. Another type of cost is the cost of training of personnel (getting to know the new currency, managing cash in the period of parallel circulation, becoming acquainted with new software, etc.). In sum, relying on the experience of the adoption of the euro in 2002, these other direct costs related to the cash changeover may be passed on to prices in the long run.

Psychological pricing is a modern marketing tool based on the theory of con-sumer psychology that, given the wide variety of goods, consumers cannot possibly remember or compare all prices. The main assumption behind psy-chological pricing is that consumers tend to ignore the last numbers on the price tags in order to simplify price comparisons, rather than rounding them to the correct number. If consumers ignore the last numbers on price tags, the merchant gains maximum profit for prices ending with “nine”. Thus, ac-cording to psychological pricing, growth in demand is higher if the price drops by one euro from EUR 100 to EUR 99, as opposed to cases where the price is lowered from EUR 99 to EUR 98 or from EUR 101 to EUR 100. So,

15 Shafir et al. (1997), p 366.

16 As former Israeli foreign minister Abba Eban remarked (in jest) at a time when Israel was experiencing three-digit inflation: “the dollar is an extremely

unstable currency: one month it’s worth 100 Israeli pounds, the next month it’s worth 200.”

17 During the parallel circulation period, merchants and services providers accept euros as well as the national currency whereas, whenever possible, they

should return the change in euros only.

Menu costs are directly related to the price change process such as printing price tags, remu-neration of extra working hours etc

People tend to observe prices in nominal values

Firms need to spend on training their employees, convert IT programs etc.

Price changes may be triggered by marketing policy of a firm


retailers may not change prices (according to changes in costs) on a current basis, but do so less frequently, until a new, attractive price is attained. There might also be a reverse psychological impact: the price ending with “nine” is linked mainly to something cheap, and the price ending with a zero indicates something expensive; therefore, in the case of luxury goods, prices ending in a zero might prove more suitable.

Thus, in sum, the price changes that might come from the changeover are associated with imperfect markets and consumers’ irrational behaviour. If markets’ operations were optimal and consumers behaved rationally, there would be no need to worry that the changeover might cause inflation. Under perfect competition, any firm trying to raise prices would lose its market share, while their expenses would not allow them to decrease prices either. Similarly, monopolies need not change prices as their price optimum in eu-ros and in national currency are equal, ceteris paribus.

Now let us turn to consumers or, more precisely, how consumers feel about price changes and what are the main factors behind the change in percep-tions in times of currency changeover.

4. Inflation perception - psychological factors behind itIt is well known that people might perceive inflation differently from that measured by the consumer price index. Many authors have assumed that perceived inflation is positively correlated with price increases of frequently purchased goods.18 The magnitude of perceived inflation is, in addition to the frequency of purchases, influenced by different psychological factors. And these are especially important in the case of currency changeover.

Since the euro cash changeover, there has been a difference in the percep-tion of wages paid in euros and the perception of wages paid in the national currency that was previously in circulation. On the one hand, nominal values of both currencies are different and this could affect the perception of prices and wages. But, on the other hand, there was not only a change in the nominal value of money – the whole system was changed from a national to single currency system. This kind of loss of national autonomy and increase in interdependence with other countries could have influenced the attitude towards the euro, and this attitude, in turn, affected the perception of wages and prices.

The introduction of the euro is associated with the following different factors:19 (a) the symbolic meaning of money; (b) how people learn, memorize, and process information; (c) how people judge and make decisions; (d) what are the current expectations, concerns, and beliefs of citizens (consumers); and (e) how attitudes are changed by propaganda and communication.

Symbolic meaning of money. The introduction of a new currency is much more than a change from one unit to another. For example, a national currency has two meanings: symbolic and economic. The best way to see this, is to look at the physical appearance of a coin – first meaning, as is usually shown on one side of the coin, expresses the symbols of authority and legitimacy of the currency and, at the same time, national sovereignty. On the other side of the coin one can find the value of that particular “unit of exchange” in economic transactions. These two sides are very intimately connected.

18 ECB (2002).

19 Burgoyne et al. (1999).

The transfer of those one time increases in costs into consumer prices is affected by the imperfec-tion of the markets

There is no average con-sumer

Getting to know new cur-rency depends how we perceive the new value of exchange

National currency has two meanings: symbolic and economic


It has been found that the subjective value of a currency is influenced by an individual’s net income and attitudes towards currency.20 But there is also evidence that people remember the inflation rate and use these memories in building their attitude towards the currency. For instance, in Poland people derived greater appreciation from winning a prize in new zlotys than in old zlotys. The latter was, in people’s minds, associated with high inflation. After the introduction of the new zloty, people no longer preferred dollars – the new zloty was much more stable than the old zloty. This means that the attractiveness of the money is determined by the attitudes of individuals.

Nonetheless, the difficulties of getting public acceptance and trust are likely to be compounded in the case of the euro, where all aspects of the unit of currency will change: its physical appearance, its name, its value and its various denominations.21 There will also be very few aspects of “associability” connecting the old currency to the euro. With the new currency, public understanding may be aided if links are drawn with exchange rates to other relatively familiar currencies. For instance, if the euro had been adopted in the UK, it would have been worth approximately 70 pennies.22 In that case, a conversion to dollars may be helpful. It should be noted that elderly people, in particular, tend to persist in having significant difficulties converting to the new money.

Learning, memorizing, and processing information. People’s opinion about their ways of gathering and processing information, may be wrong as stated in Burgoyne et al. (1999).23 For instance, one may think that repeating is necessary in order to learn something. In some cases, this is true (e.g., re-membering telephone numbers); however, if a huge amount of numbers is involved, this cannot be true – we live in era when everyone has several passwords, PINs to remember and it is hard (or even impossible) to remem-ber the prices of goods in one’s personal consumer basket. If there is a need to educate the public, it seems useful to look for some insights from cognitive psychology as suggested in Burgoyne et al. (1999) to identify how people learn, process, represent, remember, and retrieve information.24 To sum up, one may say that the relevant information should be presented in a way that is compatible with people’s existing habits and schemata (organised bodies of knowledge).25

In the context of currency exchange, the perfect example is given in the cur-rency change in the UK in 1971, when decimal currency was introduced. For assessing public’s needs for information to decimalisation there were used different types of psychological theories – the psychology of memory and the psychology of learning. The main aim of the informational campaign which was directed to the general public was concentrated in the two-month run-up to D-Day (the official date of transfer to decimalisation). This kind of gradual, ordered approach to the introduction of a new currency may be very helpful in addressing the public’s needs.26

It is well known that the perception of a currency is widely influenced by people’s attitudes towards the currency. In southern European countries, e.g., Italy, Spain, and Greece, the attitude towards the euro was predominantly positive, while the attitude in northern-central countries such as the Netherlands, the UK, and Germany was more reserved.27 Since

20 Brandstätter and Brandstätter (1996).


22 Ibid.23 Ibid.24 Ibid.

25 Burgoyne et al (1999).

26 Ibid.

27 Pepermans and Verleye (1998).

Perceptions are affected by the attitude towards currency

The way we learn affects our perception of the in-flation after the currency in circulation has changed

Authorities have had dif-ferent approaches inhelping people to get ac-customed with new cur-rency

Attitude towards the cur-rency matters...


money is an important parameter of national identity, the southern European countries seem to express it more through cultural and historical achievements, while northern-central countries place their pride in their national economic situations.28 These attitudes could be seen to agree with social identity theory, according to which nations define their social identity through dimensions in which they fare better than others. This might help us to understand why those countries that are prouder of their culture and history than their economic situation are more likely to favour the euro. One can assume that the introduction of a single currency does not jeopardise their national identity and self-esteem. Meanwhile, countries that define their national identity through economic factors may fear that, with the introduction of a single currency, they will lose their national identity.

In northern-central countries, national currencies, as constituent parts of their social identity, arouse feelings of commitment and emotional attachment. For Germany, for example, the deutsche mark (DM) was an important national symbol, standing for a successful history of currency stability, a high reputa-tion in foreign countries, and rising and stable prosperity in Germany. The German people’s identity and self-esteem have been, and still are, tightly in-terrelated with the country’s economic success and the deutsche mark, which represent the positive aspects of German history. National identity in Germany goes hand in hand with economic identity, which, in turn, provides the perception of a positive distinctiveness in comparison with other nations.29

Judgement and decision making. Even if people wish to use all the information available to them, they are not able to do so because of “bounded rationality.”30 Irrespective of whether people perceive, judge, estimate, learn, or remember, they are unlikely to be able to take account of all the information available in an accurate way and then combine it in the most rational manner to reach an optimal solution. Instead, people observe the way information is served (the “framing effects”) and compare that with other aspects of information presented at that time, including the channel of communication (the “context effect”).

In the case of a currency changeover, the information people do need concerns the price level change. A potential problem for accepting a new currency involves the above- mentioned “money illusion.” Most of the economic transactions are represented in nominal terms, and, therefore, it seems likely that people often perceive and think about economic problems in nominal terms, which may induce a "money illusion".

People could make the right decisions if there were no inflation, which is a disorienting factor.31On this account, one might think that the elimination of inflation should eliminate "money illusion" and regenerate rational behaviour. However, since "money illusion" affects wage cuts and nominal prices in separate ways, the effects of "money illusion" are likely to extend to noninflationary settings.32

In Shafir et al (1997) show that in recent research in cognitive psychology the different representations of the same situation may lead to systematically different outcomes. For example, a choice between risky prospects may be represented either in term of gains or losses, which seems natural to most people, or in terms of final assets, as recommended by normative theory.33

28 Ibid.

29 Dehm and Müller-Peters (2001), Müller-Peters (1998).

30 Simon (1957), Burgoyne, et al. (1999).

31 Fisher (1928), Fisher and Modigliani (1978).

32 (Shafir et al. 1997).

33 Ibid, p 346.

There are cultural differ-ences in forming percep-tions

People are not always rational


Another example includes the undue influence of sunk costs and the underweighting of opportunity costs relative to out-of-pocket costs.34

Another effect that is associated with judgement and decision-making is the anchoring effect, which may, like money illusion, appear as a result of the difference in nominal values. People tend to compare familiar prices with other prices and then use these comparisons to form their opinions about prices or price changes. One can call these reference prices “anchors.” Thus, if the prices of these anchors rise, then the individual will perceive higher inflation. Such anchors have a systematic influence on subsequent judgements in that, for example, higher-priced anchors lead to higher price estimations.35 In general, anchoring effects are defined as “the assimilation of a judgement of salient standard of comparison.”36

With regard to money, several lines of research have documented how price estimations systematically deviate in the direction of such anchors, and how the perception of prices systematically depends on the value of these anchors.

In bargaining research, it is well known that the first offer serves as an anchor that systematically affects the height of the first counteroffer.37 For example, if people are confronted with a high price for a product and, subsequently, this price is lowered to a more moderate price, they are more willing to buy the good than if they are confronted with the moderate offer at the beginning. This can be explained by the fact that the first price serves as a reference price and influences the perception of the subsequent moderate price via an anchoring effect.38

Since people are familiar with nominal values in their former, national currency, these familiar values might be automatically salient and serve as an anchor if people consider new prices or salaries in euros. As a consequence, if the former national currency has lower nominal values than the new currency (this is the case only for the Irish pound), the lower anchor values would decrease price estimations. If, however, the former currency has higher nominal values than the euro (the case of most countries in the euro area) from the anchoring effect, one could expect an opposite result.39

Aside from these effects caused by the changes in nominal values, the change of the money system itself from a national to an international, pan-European currency could have an impact on processes such as the perception of salaries and the estimation of prices. As stated above, people can have different attitudes towards the new currency, and these can influence the perception of money in general and processes like the estimation of prices in particular.

According to prospect theory, which says that economic situations are viewed in relation to a reference point and that losses are perceived as be-ing more significant than equivalent gains, people tend to estimate their per-sonal losses and gains compared with these anchors. Furthermore, because losses seem much bigger than gains relative to the anchor point, it can be that people perceive more losses than gains when a new currency is introduced (even when, in absolute terms, the changes are equal). This situation can be the cause of economic or symbolic conditions:40 (a) it seems

34 See also Thaler (1992).

35 Northcraft and Neale ( 1987).

36 See Mussweiler and Strack ( 2000), p.1038, Jonas et al. (2001)

37 See Kristensen and Gaerling (1997), (2000) .

38 Jonas et al (2001).

39 Ibid.


"Anchors" are widely used

People tend to notice ad-verse developments more


that most of the benefits are expected to accrue to those in finance and business; and (b) instead of a national currency with all its symbolic referents, people have to deal with the potentially “faceless” euro. So, it is probable that, when prices are converted from an old currency, any form of “rounding up” of prices in favour of the seller is likely to be felt more keenly as a loss, than any equivalent gain from “rounding down” in favour of the buyer.

But even if prices were calculated correctly, customers tend to perceive them as higher. The main reasons behind this are simply mistakes in calculations. For example, in Germany the exchange rate was EUR 1 equals DM 1.9533, but people tended to calculate using a ratio of 1:2. As a consequence, they overestimated prices substantially. In the relevant literature, this is called a “selective error correction,” which means that people do not correct their cal-culations when the results confirm their beliefs.

Expectations, concerns, and beliefs. As was stated above, the attitude towards a new currency can influence the perception of prices and wages. As discussed, people’s views in the UK on the single currency are influenced by the strength and character of their attachment to their national identity. Just as money can be seen to have two “sides” - economic and symbolic - it may also be a part of national pride. The latter refers to cultural/sentimental attachment to symbols of nationhood such as the royal family in the UK, as well as a more instrumental attachment based upon the perceived benefits of citizenship.41 The strongest direct influence on anti-euro sentiment is the cultural dimension of attachment, with the effects of instrumental attachment being moderated by the perceived benefits of adopting the euro.42

As was stated above, the attitude towards the euro is affected by how people felt about their own currency – the deutsche mark was much more appreciated then the euro. Even US dollars seemed, from the point of view of euro area consumers, more attractive than the euro.

If such a sentimental attachment to the national currency exists, it is hard to make people accept the euro. This is to a large extent the case in Estonia as well. Estonians saw themselves as belonging to an independent nation when they introduced the kroon. After the collapse of the Soviet Union, the three Baltic countries introduced their own national currencies – this made people understand that these countries were independent and sovereign states. For that reason, we believe, that, in the case of Estonia, the attitudes towards the euro are substantially influenced by national identity, which is determined through the national currency.43

Propaganda, communication, and attitude change. The literature dealing with propaganda, communication, and changing attitudes is a “two-edged sword”: some of the literature argues about tactics of mass communication and persuasion and the susceptibilities of populations to persuasion, while another branch of the literature deals with protecting the consumer. On the one hand, one may wish to ensure that citizens participating in a democratic process are as fully informed as possible, and that people have equal opportunities to learn about the new currency. On the other hand, one doesn’t want to make consumers victims of hype and half-truths propagated by politicians.

People’s demand for information can be addressed by applying suggestions from research on communication models.44 The “communication

41 Cinnirella (1996).

42 Routh and Burgoyne (1998).

43 It is quite common for elderly people to think that Estonia has departed from one union to join another, and the meaning of the union is not so positive.


Perception of price changes is closely re-lated to the attitude to-wards single currency

Currency has two mean-ings – symbolic and eco-nomic

The national currency in Estonia was a symbol of national independency and sovereignty

Educating people using mass media might act like a "two-edged sword"


organization” approach45 and “innovation-diffusion theory”46 say that communications are most effective when both the mass media and interpersonal channels are used. The mass media will be most useful in providing information and generating knowledge about the euro. This foundation can be built upon using existing social networks and interpersonal contacts. A greater impact on attitudes will come from small group discussions about the impact of the euro on the local community, conducted by opinion leaders and esteemed figures in the community.47

5. Inflation perception, expectations, and actual inflation in euro area countries after euro adoption

Perceived inflation can be defined as consumers’ own rate of inflation, pro-duced, for instance, by the media or personal experience. According to this definition, it can hardly be objectively measured. Most of the research uses the Consumer Confidence Barometer survey, conducted by the European Commission; this survey, which is carried out every year, includes all EU member states and thus gives us the opportunity to compare different coun-tries’ inflation perceptions. Usually the measure of perceived inflation is given as the percentage change between respondents who say that prices have risen and those who believe that prices have fallen. Another way to calculate perceived inflation is to estimate it from survey results, but this process is subject to restrictive assumptions.

The exact wording of the question in the consumer survey is “How do you think that consumer prices have developed over the last 12 months?” Possi-ble responses are as follows: (a) “risen a lot”; (b) “risen moderately”; (c) “risen slightly”; (d) “stayed about the same”; (e) “fallen”; and (f) “don’t know.” The percentage balance between the different answers is calculated in the following way:

Balance = percentage (a) + 0.5 x percentage (b) –0.5 x percentage (d) –percentage (e)

Given the equation above, the value of 20, for example, would mean that the share of those who think prices have risen is 20 percentage points higher than the share of those who think the opposite. The problem here is that a measure like this is not directly comparable with actual inflation.

In addition, the perceived inflation found in surveys can be calculated as the perceived inflation rate. According to Berk (1999) and Forsells and Kenny (2002), the perceived inflation rate is calculated as follows. The inflation rate perceived by people is, by assumption, normally distributed with a certain mean and a certain variance. It follows that the shares of different survey re-sponses can be interpreted as probabilities. The proportions of certain re-sponses (e.g., “fallen”) thus can be interpreted as the probability that the perceived inflation is between certain upper and lower thresholds. Addition-ally assuming that these thresholds are symmetrically located around zero, one can, by means of probabilities derived, derive a relation between the mean and the variance of the distribution in request. In order to calculate the mean of the distribution, one then has to assume that the mean of perceived inflation equals the mean of the statistically measured inflation rate. The mean of the distribution estimated in this way is interpreted as the inflation

45 See Rothman (1974).

46 See Rogers (1983).


Perceived inflation is measured using mainly survey results


rate perceived by the general public. All in all, this estimation procedure de-pends on several assumptions, the plausibility of which may certainly be questioned.

The pioneering works of Kahneman and Tversky (1979) shows that the per-ception of the economic situations depends on the way in which it is pre-sented, or on its framing. The consumer is confronted with inflation when she buys something. And she will perceive inflation more powerfully when the goods she buys have become significantly more expensive. But, on the other hand, she will barely notice price changes of goods she rarely buys.

Another way to measure perceived inflation is by an index.48 There are dif-ferent effects (loss aversion and isolation effect49) that need to be taken into account, and for this purpose Brachinger converted the prices to account for this loss aversion and weighted them according to the frequencies with which the consumer buys each of the goods concerned.

This index actually differs from the consumer price index, since this one in-cludes primarily everyday goods that are purchased frequently (in CPI, the frequencies of purchases are not taken into account).

In this paper, we use the methodology employed in Cornille and Stragier (2007) and Aucremann et al (2007) to convert the qualitative data of per-ceived inflation into a quantitative indicator. This indicator will be accorded the same average value and the same scale as the harmonised index of consumer price (HICP) inflation:

i

B

iitPit i

i

SS

BB

,

where Pit is perceived inflation quantified for country i in period t. i and

iS are, respectively, the average and the standard deviation of HICP infla-

tion, while iB and SBi are the corresponding statistics for the balance of

opinions for country i. The averages and standard deviations are calculated over a reference period for which there is considered to be a stable relation-ship between measured and perceived inflation. In this paper, the period dif-fers for the selected countries. In old member states (OMS),50 the period from 1995 until 2001 is used (they adopted the euro on January 1, 2002); for Slovenia, the period lasts until the end of 2006; for Malta and Cyprus, until the end of 2007; and, for the Slovak Republic, until the end of 2008. Last but not least, for Estonia the period lasted until the end of the 2010.51 For the sake of having a control group, we set up the group of countries that haven’t adopt the euro – the United Kingdom, Sweden, Latvia, Lithuania, the Czech Republic, Hungary, Romania, Bulgaria, and Denmark.

48 Developed by Hans Wolfgang Brachinger (see for instance Brachinger (2005),(2006))

49 Loss aversion – consumers respond more sensitively to the price increases than to reductions;

isolation effect – purchases are considered in isolation ,or, in other words, price increases are not offset against price decreases.

50 Austria, Belgium, Germany, France, Italy, Ireland, Spain, Portugal, Finland, the Netherlands, Greece, and Luxembourg .

51 Those countries are counted in this paper as New Member States (NMS), except Estonia. In the case of Malta and Cyprus, the available data start in2002

and 2001, respectively. Therefore, one may consider leaving these two out of the analysis.

We observe prices of goods and services that we buy, not others - iso-lation effect

Another way to measure inflation perception is to calculate consumer price index that takes into ac-count the frequency of purchases


Euro area actual and perceived inflation rate (in percent)

-1%

0%

1%

2%

3%

4%

5%

1996 1998 2000 2002 2004 2006 2008 2010

HICP, yoyperceived inflation, yoy

Source: Eurostat, ECFIN, author's calculations

We are aware that all these countries differ in terms of the structure of the economy and the level of development, but in respect to the problem of in-terest, similar factors may influence the perception of price changes in the euro area as well as in non-member countries. As we are dealing with rather different countries, we divided them into three groups: (a) the Baltic states (BS = Latvia, Lithuania and Estonia; (b) the central-eastern European coun-tries (CEEC = Hungary, Poland, the Czech Republic, Poland, Bulgaria, and Romania); and (c) the non-euro area developed countries (NEAC = the UK, Sweden, and Denmark).

Data used in this analysis are provided by ECFIN and Eurostat. In the case of the OMS, the data series of perceived inflation usually started in 1995, ex-cept for Finland and Austria (data for both are available since 1996) and for Luxembourg. The latter is quite exceptional – the survey data are available only since 2002, and, therefore, Luxembourg is left out of this analysis. The HICP is available only from 1996 onwards. In terms of testing the above-mentioned assumption that the relationship of perceived and actual inflation is stationary around the constant, we use the unit root test. For the OMS, the data for all but Finland suggest that the relationship between actual and per-ceived inflation is stationary, i.e., in terms of the usual economic environ-ment, people perceive inflation in a rational way. In the BS group, data on the Lithuanians’ perceived inflation are available only since May 2001; in the CEEC group, the same holds for Bulgaria, Romania, and Poland; and, in the NEAC group, survey data on Sweden are available since October 1995. Al-most all countries have actual inflation (HICP) data available from 1996 on-wards, except for Bulgaria (available from December 1996 onwards).

Perceived inflation is calculated for all these countries (see the graphs in Appendix 2), and, to test whether the relationship between these inflation rates is stationary, we calculated the difference between the perceived and actual inflation rate and used the unit root test to test for stationarity before the adoption of the euro (in the case of euro area countries); after that, we looked at the same difference for the whole sample. This allows us to com-pare both tests and to check whether the relationship between these two changes significantly. Results of the tests are presented in Table 1 in Ap-pendix. Under the null hypothesis, the difference is nonstationary, i.e., it is assumed to have a unit root. We reject the null hypothesis at the level of 10% (the p-value should be less than 0.1) for most of the countries (except for Finland, Ireland, and the Netherlands) for the pre-euro period; in this

We use data provided by Eurostat and ECFIN

People perceived infla-tion quite objectively be-fore the euro adoption in selected countries


case, the difference between quantified perceived and actual inflation is sta-tionary. This means that there has been a nonstationary relationship be-tween actual and quantified perceived inflation in Finland, Ireland, and the Netherlands in the past, which, in turn, indicates that the instability problem for the more recent period is irrelevant. For all other euro area countries, the null hypothesis is rejected, which means than one can agree that there was a stationary relationship between perceived and actual inflation. This, in turn, means that people’s perception of the price changes was relatively good be-fore the euro cash changeover, and that the deviation from this stable rela-tionship was quite fugacious.

For the whole period, the null hypothesis cannot be rejected in the case of Austria, France, Greece, and the Netherlands. Since the latter country had a nonstationary relationship before euro adoption as well, we do not discuss it any further. This is a bit different result from Jemec’s (2010), who found that most of the euro area countries had nonstationary relationships between perceived and actual inflation for the whole period (until August 2009). Our evidence shows that the effect of the euro cash changeover will vanish, and that the stationary relationship between perceived and actual inflation will remain in place. Even though the relationship will remain stationary in the long run, the gap between perceived and actual inflation did widen shortly after the euro cash changeover (see graphs in the Appendix), and the tests taken do not say anything about causality (i.e., whether or not perceived in-flation causes actual inflation. as suggested by the theory). Therefore, Granger causality tests were taken.

For comparison, tests were made for non-euro area countries as well; before the first wave of euro cash changeovers (in 2002), we can reject the null hy-pothesis for most countries (for Lithuania, Poland, Romania, and Bulgaria, the time series were too short), except for the UK. For the whole period, the stationary relationship remains (except for Poland).

The other question that arises in the literature is whether changes in per-ceived inflation may cause changes in expected and, through that – actual inflation. To answer this question, we have constructed Granger causality tests (see results in Appendix, Table 2), which are usually applied to test cer-tain relationships between variables. In this paper, the variables are per-ceived, expected, and actual inflation in selected countries. The test results may not indicate a strong one-way relationship or the direction of the influ-ence – but the results will show how much information is in one variable to predict the other. The null hypothesis is that variable A does not Granger cause variable B, which means that, if we can reject the null hypothesis, there is a relationship between variables. The tests, the results of which are presented in the Appendix, are run using stationary variables (monthly growth rates), and all tests are made with lags of 2, 6, and 12 months. In Ta-ble 2, we present only statistically significant relationships (at the 10% level, i.e., the p value is less than 0.1).

Test results show in many cases a rather strong relationship between these variables. Monthly changes in actual inflation cause changes in expectations in Germany and changes in perceptions in Austria, Italy, and Slovenia. It would not be surprising to find this relationship to be more widespread as, according to the questionnaire, the inflation perception indicator should be explained by consumer price inflation, and expected inflation should also be related to actual inflation – if we assume stable inflation. Changes in expec-tations influence actual inflation in Austria, Estonia, Slovenia, and the UK. This result is also quite expected – in many economic theories, the actual inflation rate is determined by expectations. It is rather interesting that changes in expectations have effects on monthly changes in inflation per-

The effect of the cash changeover on people's perceptions will vanish gradually

In non-euro area coun-tries the stationary rela-tionship between per-ceived and actual infla-tion remains

Granger causality tests will show how much in-formation one variable has to predict the other

Test result differ among countries


ceptions in so many countries. The relationship between monthly changes in expectations and monthly changes in inflation perceptions is not so clear, but they are closely related. This is partly explained by the experimental psychology literature,52 and, as pointed in Jemec (2010), the influence of in-flation perceptions on inflation expectations is explained by the rigidity of the human mind, i.e., if one thinks that prices have been rising, one most proba-bly expects them to rise further. These two indicators are closely related, and, at different times, the two data series may explain each other in many countries.

A monthly change in perceived inflation affects monthly changes in actual inflation, according to the tests in Ireland, the Netherlands, Sweden, and Slovenia. In the case of Slovenia, the relationship goes both ways – changes in actual inflation cause changes in inflation perceptions and vice versa.

6. What will it be for Estonia? Short discussion of the Estonian case

Estonia is now facing the question of whether the changeover will bring about a considerable price increase. One may assume that, as in the euro area, some of the regular price changes might be timed for the changeover period because of the menu costs in Estonia, as well as the other euro area countries. However, many entrepreneurs have agreed not to increase prices (the Agreement of Honest Pricing, or Ausa Hinnastamise Lepe), and there has been no evidence yet that they have not kept their part of the deal. At the same time, expense arguments might have a more significant impact on the prices of certain goods and services (price increases are allowed if they are economically justified), and therefore the price rise might be associated with the new currency in circulation. The actual price changes are, as de-scribed in economic theory, influenced by competition on the market – the tighter the competition, the less likely prices will increase due to the change of currency in circulation. Knowing that Estonia is a well-functioning market economy,53 the euro adoption should not have a significant inflationary im-pact on price levels in Estonia (according to the recent study by Eurostat, the effect of euro cash changeover on Estonian price level is 0.2-0.3 percentage points54). Most of the Estonian retail sector is concentrated in large chains, which means that pressure for price increases stemming from cash change-over should be smaller in Estonia than in countries where small shops con-stitute the majority of the retail sector. But, as the experience of other euro area countries has shown, prices of certain services may indeed increase (e.g., restaurants and cafes, bus tickets, etc.) due to rounding and/or post-poned price increases. The latter might be especially the case for restau-rants and cafes.

On the basis of the experience of countries that have already adopted the euro, it cannot be ruled out that the Estonian population might perceive the rise in prices to be higher than the actual price growth; this may be caused by different factors (like the food price increase that will be associated with the new currency, e.g.). Before the EU accession, consumers’ fears of infla-tion grew, due to the heavy media attention as well as the expected changes (see graph in the Appendix). After Estonia joined the EU, the number of those consumers who felt that prices were increasing faster, grew. Percep-tions after the euro cash changeover will most probably rise, as seen in the

52 See, for instance ,Traut-Mattausch et al (2004), among others.

53 Lättemäe (2005).

54 Compliance Monitoring Information Note for Estonia

The same factors affect Estonians’ perceptionsas in other euro area countries

We know that prices change due to different reasons, but people might associate it with euro adoption


experience of other euro area countries. It might happen that increases in prices in certain fields (e.g., electricity and public transport) will be more marked than the more modest price increases (or even declines) of some goods in the basket of goods and services, as people have different con-sumer baskets; moreover, as mentioned above – people observe the prices of those goods that they purchase more often and do not take into account the price falls of those goods they seldom if ever buy, but which are taken into account in the overall consumer price index.

In sum, prices will change in Estonia, as well as worldwide, for different rea-sons, but the change in prices due to the change of currency in circulation should not be large. Prices have been rising, and it might very well be the case that people in Estonia will correlate the current price rise with the new currency. As is said in the relevant literature – it is not wrong how people perceive inflation, since every household has a different consumer basket, which hardly coincides with the average consumer basket calculated by the Statistical Office. Additionally, people observe prices in isolation and re-member only the prices of a few products/services; if those prices have changed, they amend their perceptions accordingly. And as mentioned above, if people make mistakes in calculating prices into kroons, they tend not to correct them if these miscalculations coincide with their beliefs about the new currency. Luckily, more and more people favour a common currency – in January 2010 it was a bit more than half of the respondents of a survey, and, a year later, in January 2011 already more than 60% of the respon-dents favoured the euro.

7. Conclusion

The discussion about inflation perception and euro adoption has been quite intense in recent years, with most of the papers dealing with the first wave of currency changeover (in 2002). We discuss currency changeover a bit more broadly, considering the reasons behind price increases in times of no shocks and in times of shocks such as a change of currency in circulation. Discussing the relationship between actual and perceived inflation, one needs to explain why people may change their opinions about price in-creases after the country has adopted a new currency. The psychological factors behind adopting a new currency and inflation perceptions have also described in this paper.

The first part of the paper is devoted to the topic of price changes, i.e., why prices change during so-called stable economic development. We then turned to the reasons why prices change after a shock like a currency changeover. From the literature, we found that prices tend to be rather sticky, and on average prices change once a year (this frequency differs among different groups of goods and services). According to a survey con-ducted in Bank of Estonia, the price-setting behaviour of Estonian firms does not differ much from their euro zone counterparts (except that competition is said to be perceived as stronger than in the euro area).

But what about the factors that, in addition to regular factors, influence price changes in times of currency changeover? As is known in the case of perfect competition and with rational consumers, the change in the tool of exchange should not transfer into prices. In reality, however, people are not rational (bounded rationality), and their decisions are based completely on emotions, the information available to them, and other factors. They are affected by money illusion – observing only the nominal value of the currency, they therefore may overlook their consumption habits. Firms are, however, facing different costs during the currency changeover, like the need to change price


tags (menu costs), IT costs, the need for larger amounts of cash during the period of parallel circulation, etc. The transfer of these costs into prices de-pends on firms’ pricing strategies and their beliefs about the nature and per-sistence of the costs (enterprises have identified the increased costs as the main reason behind the price rise). Besides, the price changes may also be affected by marketing strategies. Specifically, firms may round prices up-wards using psychological pricing as one marketing tool.

After discussing price changes from the firm’s side, we discussed the psy-chological factors behind consumers’ inflation perception, especially after currency changeover. The way people learn, memorize, or identify them-selves – all this has an impact on the perception of price changes. The tool of consumer psychology is useful in understanding this phenomenon.

In the empirical analysis, we analysed the euro area countries together with other EU countries, in order to add non-euro area countries as a control group. Our findings show that there is a stationary relationship between ac-tual and perceived inflation in most of the countries before 2002 (before the first wave of the euro cash changeover), which indicates that people tend to perceive price changes in a stable environment quite rationally. After the euro cash changeover, as was found in other similar papers, the picture changes somewhat – perceived inflation was much higher than actual infla-tion. The gap between these two persisted until 2008, when both started to move similarly again. Our test results for the whole period show that in most of the countries the stationary relationship between actual and perceived in-flation remained. Many papers that use shorter time series show much more persistent results of breaking the stationary relationship between actual and perceived inflation after the currency changeover. One may say that, shortly after the changeover, the gap between perceived and actual inflation did widen for some years and, after that, actual inflation began to catch up with the perceptions; this might indicate that people’s beliefs about price changes self-fulfilled after some years.

Tests on the relationship between actual and perceived inflation do not, however, show the magnitude or direction of the influence that people’s per-ceptions may have on actual and/or expected inflation. Granger causality tests show a rather strong interrelationship between expectations and per-ceptions, which one may explain by the rigidity of the human mind. Effects of changes in perceived inflation on actual inflation were evident in only a few countries (Ireland, the Netherlands, Sweden, and Slovenia). At the same time, perceptions have an indirect effect on changes in actual inflation in Es-tonia – changes in perceived inflation influence changes in expectations, which, in turn, affect changes in actual inflation.

Many opinion polls suggest that people’s strongest fears in relation to euro adoption have been of faster inflation accompanying the euro cash change-over (which, in turn, has gained a lot of media attention – the price increases have been discussed more thoroughly than price decreases, if the latter have been discussed at all). The reasons behind this fear are mostly psycho-logical, but this does not decrease the need for their serious consideration and for the dissemination of unbiased and relevant information on inflation issues. Relying on the euro area experience, the euro cash changeover may not necessarily bring about a crucial price increase or acceleration of infla-tion, but the changes may be more pronounced in the prices of everyday goods, and, therefore, perceived inflation may increase.


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43. Rogers, E.; “Diffusion of Innovation”; New York, Free Press; 1983.44. Routh, D.A., Burgoyne, C.B., "Being in two minds about the single

currency: a UK perspective on the euro", Journal of Economic Psy-chology 19(6), pp 741-754, 1998.

45. Rothman, J.; “Planning and organizing for social change: Action principles for social sciences”; New York: Columbia Press, 1974.

46. Shafir, E., Diamond, P. and Tversky, “A. Money illusion”, The Quarterly Journal of Economics 112(2): 341–74, 1997.

47. Simon, H., "Amounts of fixation and discovery in maze of learning behaviour", Psychometrika, Springer, Vol. 22(3), pp 261-268, September 1957.

48. Stix, H.; “Perceived Inflation and the Euro: Why High? Why Persistent?”, mimeo, 2006.

49. Thaler, R. H., "The Winner's Curse: Paradoxes and Anomalies of Ecnomic Life", New York: Free Press, 1992.

50. Traut-Mattausch, E.; Schulz-Hardt, S.; Greitemayer, T.; and Frey, D.; “Expectancy Confirmation in spite of Disconfirming Evidence: The Case of Price Increases Due to the Information of the Euro”; European Journal of Social Psychology; 34 (2004), pp 739-760.

51. ECB (2002), Recent Developments in Consumer Inflation Perception” European Central Bank Monthly Bulletin, July: 18-19

52. Eurostat (2003), “Euro changeover effects”, annex to press release dated 18 June 2003

53. Eurostat (2011, march), "Eurole üleminek ja inflatsioon Eestis"54. Deutsche Bundesbank (2004), The euro and prices two years on,

Monthly Report, Vol. 56, No. 1, pp.15-28, January


Appendix 1Table 1. Unit root tests at the country level

P-value

lag length=0 (based on SIC max lag) P-value

lag length=0 (based on SIC max lag)

Austria 0.0461 10 0.2163 13Belgium 0.0373 10 0.0435 13Cyprus 0.0049 11 0.0012 12Germany 0.0005 10 0.0626 13Ireland 0.1573 10 0.0965 12Spain 0.0313 10 0.0417 13Finland 0.1994 10 0.0969 13France 0.0499 10 0.1434 13Greece 0.0471 10 0.3982 13Italy 0.0090 10 0.0002 13Malta 0.0035 10 0.0313 11Netherlands 0.4485 10 0.1721 13Portugal 0.0717 10 0.0214 13Slovak Republic 0.0015 12 0.0008 13Slovenia 0.0004 12 0.0078 13

Bulgaria 0.0613 12Denmark 0.0135 10 0.0002 13Czech Republic 0.0761 10 0.0281 13Hungary 0.2054 10 0.0430 13Estonia 0.0799 10 0.0089 13Latvia 0.0003 10 0.0006 12Lithuania 0.0246 12Poland 0.2424 12Romania 0.0062 12Sweden 0.0402 10 0.0000 13United Kingdom 0.1112 10 0.0015 13

(the series too short)



(series too short)

before euro adoption

Non-euro area countries

Euro area countries

whole period (until 12.2010)


Table 2. Results of the Granger causality tests

Inflation does not Granger cause inflation expectations

Germany 2 177 2.61959 0.0757

6 173 2.17734 0.0478

12 167 1.98448 0.0297Inflation expectation does not Granger cause inflation Austria 12 167 2.00859 0.0275

Estonia 2 177 2.34431 0.099

Slovenia 2 175 2.94943 0.0551

UK 12 166 1.62345 0.0914Inflation does not Granger cause inflation perceptions

Austria 6 173 2.01669 0.0664

12 167 2.01113 0.0272

Italy 2 174 5.04299 0.0075

6 166 3.32389 0.0042

12 154 1.72892 0.0677

Slovenia 2 175 5.11897 0.0069

6 171 2.02757 0.065

12 165 1.98604 0.0297Inflation perceptions does not Granges cause inflation

Ireland 6 141 1.90585 0.0847

Netherland 12 167 3.2509 0.0004

Sweden 2 177 2.4279 0.0912

Slovenia 6 171 1.94429 0.0769

12 165 1.74454 0.0635

Inflation perceptions does not Granger cause inflation expectations

Bulgaria 2 114 3.94305 0.0222

6 110 1.45798 0.2008

12 104 1.92248 0.0438

Estonia 6 186 9.8456 0.0000

12 180 18.1456 0.0000

Spain 2 186 2.73797 0.0674

12 166 3.35656 0.0003

Germany 6 186 3.69026 0.0018

12 180 1.97934 0.0295

Hungary 2 190 5.01064 0.0076

Ireland 2 157 1.2427 0.2915

6 153 2.25599 0.0414

12 147 1.60591 0.0984

Italy 6 179 5.10059 8.00E-05

12 167 2.33224 0.0093

Malta 2 96 3.39563 0.0378

6 92 2.39397 0.0354

12 86 3.25383 0.0012

Slovenia 2 176 3.04115 0.0504

Slovakia 2 136 7.73718 0.0007

6 128 5.16581 0.0001

12 116 3.79967 0.0001


Inflation expectations does not Granger cause inflation perceptions

Austria 12 171 10.7953 4.00E-15

Bulgaria 2 114 8.2447 0.0005

6 110 3.06972 0.0086

12 104 2.94582 0.002

Cyprus 2 114 0.87186 0.4211

6 110 1.84131 0.099

12 104 1.69719 0.0832

Germany 2 190 22.1096 0.000

6 186 7.38986 0.000

12 180 7.39239 0.000

Estonia 2 190 3.22693 0.0419

12 180 2.16493 0.0159

Spain 6 178 52.763 6.00E-36

12 166 34.4967 5.00E-36

Hungary 2 190 18.1233 6.00E-08

6 186 7.95344 1.00E-07

12 180 4.58848 2.00E-06

Latvia 2 190 22.8129 1.00E-09

6 186 8.20342 8.00E-08

12 180 4.27521 8.00E-06

Malta 6 92 2.45396 0.0315

12 86 4.142 0.0001

Netherlands 2 190 15.6545 5.00E-07

6 186 8.50835 4.00E-08

12 180 5.99334 2.00E-08

Romania 2 114 3.28876 0.041

6 110 3.88585 0.0016

12 104 3.05261 0.0014

Slovenia 2 176 2.26827 0.1066

6 172 1.91623 0.0813

12 166 3.0101 0.0009

Appendix 2Perceived and actual inflation in selected countries

-1%

0%

1%

2%

3%

4%

5%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Perceived inflationActual inflation

-4%

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0%

2%

4%

6%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-20%

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95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-1%

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3%

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8%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-2%

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5%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


Austri a Belgium

Cyprus Finland

France Germany

SwedbankEconomic Research DepartmentSE-105 34 Stockholm

Phone +46-8-5859 1028

[email protected]

www.swedbank.com

Legally responsible publisher

Cecilia Hermansson, +46-8-5859 1588

Annika Paabut, +372 6 135 440

Elina Allikalt, +372 6 131 989

Swedbank’s Discussion Paper is distributed as a service to our customers. We have used what we believe to be reliable sources and working processes when preparing the analyses in our publication. We cannot, however, guarantee the accuracy or completeness of the analyses, and assume no liability for any inac-curacies or deficiencies in the basic data, or the adaptation thereof. Readers are encouraged to base any (investment) decisions on other materials as well. Nei-ther Swedbank nor its employees or other contributors can be held liable for loss or injury, direct or indirect, due to any inaccuracies or deficiencies published in Swedbank’s Discussion Paper.

-8%

-4%

0%

4%

8%

12%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-4%

-2%

0%

2%

4%

6%

8%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-1%

0%

1%

2%

3%

4%

5%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-6%

-4%

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0%

2%

4%

6%

8%

10%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-6%

-4%

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0%

2%

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6%

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10%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-2%

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2%

3%

4%

5%

6%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


Greece Ireland

Italy Netherlands

Portugal Spain

-4%

0%

4%

8%

12%

16%

20%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-40%

-30%

-20%

-10%

0%

10%

20%

30%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-10%

-5%

0%

5%

10%

15%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-2%

-1%

0%

1%

2%

3%

4%

5%

6%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-15%

-10%

-5%

0%

5%

10%

15%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


Sweden Slovak Republic

Slovenia United Kingdom

Czech Republic

SwedbankEconomic Research DepartmentSE-105 34 Stockholm

Phone +46-8-5859 1028

[email protected]

www.swedbank.com

Legally responsible publisher

Cecilia Hermansson, +46-8-5859 1588

Annika Paabut, +372 6 135 440

Elina Allikalt, +372 6 131 989

Swedbank’s Discussion Paper is distributed as a service to our customers. We have used what we believe to be reliable sources and working processes when preparing the analyses in our publication. We cannot, however, guarantee the accuracy or completeness of the analyses, and assume no liability for any inac-curacies or deficiencies in the basic data, or the adaptation thereof. Readers are encouraged to base any (investment) decisions on other materials as well. Nei-ther Swedbank nor its employees or other contributors can be held liable for loss or injury, direct or indirect, due to any inaccuracies or deficiencies published in Swedbank’s Discussion Paper.

-4%

0%

4%

8%

12%

16%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-10%

-5%

0%

5%

10%

15%

20%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Actual inflationPerceived inflation

-4%

0%

4%

8%

12%

16%

20%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-30%

-20%

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10%

20%

30%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-400%

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100%

200%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


-800%

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-400%

-200%

0%

200%

400%

600%

800%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


LatviaLithuania

Poland Estonia

Romania Bulgaria

Economy & Finance

Discussion Paper, No. 24 - June 14, 2011