Assessing the Relationship Between Inflation Expectations and Central Bank Interest Rate Policies

Posted: Nov 19, 2022

• Evelyn Scott
• Evelyn White
• Evelyn Young

Abstract

The relationship between inflation expectations and central bank interest rate policies represents one of the most fundamental yet complex dynamics in modern macroeconomics. Traditional economic models, particularly those based on rational expectations and linear response functions, have provided valuable insights but increasingly fail to capture the nuanced interactions in today's digitally interconnected global economy. This research introduces a groundbreaking computational framework that merges quantum-inspired optimization with behavioral economic modeling to address these limitations. The conventional approach to monetary policy analysis has predominantly relied on variations of the Taylor rule and New Keynesian frameworks, which assume relatively straightforward relationships between policy rates and inflation expectations. However, the emergence of digital communication networks, algorithmic trading, and real-time information dissemination has fundamentally altered how economic agents form and update their expectations. These changes necessitate a more sophisticated analytical approach that can accommodate the multi-dimensional, non-linear, and often paradoxical nature of expectation-policy interactions. Our research addresses three core questions that have remained inadequately explored in the existing literature. First, how do heterogeneous expectation formation mechanisms, ranging from fully rational to boundedly rational and socially influenced, interact with central bank policy credibility in digital information environments? Second, what computational limitations do traditional monetary policy rules encounter when dealing with high-inflation regimes characterized by multiple equilibria and path dependency? Third, how can principles