Households cut spending because they expect inflation, not just higher loan costs

A new study finds that when interest rates go up, households cut their spending for a different reason than economists thought. People reduce what they buy because they expect prices to rise, not just because borrowing money costs more.

For decades, central banks have used interest rates to slow down the economy, assuming people would borrow less. This paper shows that people actually cut spending because they expect inflation to get worse, which means the central bank's main lever might be working for the wrong reasons. This changes how central banks might need to think about communicating their policy decisions.