Understanding economics of inflation expectation in light of modern cognitive psychology

Submission note: A thesis submitted in total fulfilment of the requirements for the degree of Doctor of Philosophy to the School of Economics, Faculty of Business, Economics and Law, La Trobe University, Bundoora.

This thesis is an attempt to develop a cognitive psychology model which enhances our understanding of inflation expectation. It investigates inflation expectation formation in both individual and aggregate level. At the individual level, empirically proven cognitive psychology is taken to build a conceptual framework and then extended to form a mathematical model that describes how economic agents form inflation expectations. It also argues that inflation expectation is based on inflation perception and some macroeconomic information perceived by agents. At the aggregate level, this thesis investigates the statistical distribution of inflation expectations which is generated by the mathematical model. It shows that, due to the central limit theorem for median, shapes of the distribution of price perception and hence inflation expectations have similar distributions in different countries. Furthermore, we use this model to understand what information agents used to form inflation expectations.