Rational Inattention, Inflation Developments and Perceptions after the Euro Cash Changeover

52 Pages Posted: 23 Mar 2006

See all articles by Michael Ehrmann

Michael Ehrmann

European Central Bank (ECB); Bank of Canada

Date Written: February 2006

Abstract

This paper uses the euro cash changeover to test theories of finite informationprocessing capacities on the side of consumers. It argues that the denomination of prices in a new currency has increased the information-processing requirements for consumers by more than for sellers, a wedge that can lead to price increases. The size of the wedge should depend on the complexity of the currency conversion rates. In line with this theory, the paper finds that the evolution of prices for food products around the cash changeover varied across countries, depending on the complexity of conversion rates. These changeover effects are found in particular for goods with prices below one euro sold in mid-priced stores. The paper also finds that cross-country differences in the mismatch of perceived and actual inflation in the aftermath of the cash changeover are linked to differences in the complexity of conversion rates.

Keywords: rational inattention, perceived inflation, euro cash changeover

JEL Classification: D84, E31, E58, L11

Suggested Citation

Ehrmann, Michael, Rational Inattention, Inflation Developments and Perceptions after the Euro Cash Changeover (February 2006). ECB Working Paper No. 588. Available at SSRN: https://ssrn.com/abstract=881023

Michael Ehrmann (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344/7327 (Phone)
+49 69 1344/6000 (Fax)

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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