Inflation misperceptions of consumers complicate the conduct and communication of monetary policy and can undermine the credibility of the central bank’s inflation target. This paper empirically investigates the determinants of inflation misperceptions by extending a rational inattention model to incorporate distorted signals from salient prices. We estimate the model using rich micro-level panel data for the euro area drawn from the ECB Consumer Expectations Survey. We find that consumers misperceive inflation both because they are inattentive to inflation and because they overweight food price inflation relative to headline inflation. In contrast, distortions stemming from energy prices are not significant. Financially literate consumers exhibit lower inflation misperceptions and greater attention to inflation, while women have more pronounced inflation misperceptions and place larger weights on salient prices. Finally, we show that attention to inflation is higher and misperceptions are lower in response to inflationary than to disinflationary news.
