Central bank models miss why people cut spending when interest rates rise

A new study finds that when central banks raise interest rates, people cut their spending. They do this because they expect higher rates to cause more inflation, which is not what economic models predict.

Central banks use models to predict how their interest rate changes will affect the economy. This paper shows those models might be wrong about why people change their spending habits. If central banks misunderstand how people react, their policy tools might not work as intended.