Usually, small-scale model error is present in groundwater modelling because the model only represents average system characteristics having the same form as the drift, and small-scale variability is neglected. These errors cause the true errors of a regression model to be correlated. Theory and an example show that the errors also contribute to bias in the estimates of model parameters. This bias originates from model nonlinearity. In spite of this bias, predictions of hydraulic head are nearly unbiased if the model intrinsic nonlinearity is small. Individual confidence and prediction intervals are accurate if the t-statistic is multiplied by a correction factor. The correction factor can be computed from the true error second moment matrix, which can be determined when the stochastic properties of the system characteristics are known.