Question

A central bank that does NOT follow the Taylor principle will fail to raise nominal interest rates by more than the increase in expected inflation. Therefore, higher inflation will lead to a ________ in real interest rates, resulting in ________-sloping monetary policy curves.

Answer 1

Decline & Downward

Step-by-step explanation:

Taylor rule states that when the current inflation is higher than the target inflation the central bank should increase the interest rates. Therefore, central banks that does not follow Taylor rule, will not increase the interest rate in case of higher inflation expectation that eventually lead to:

• Decline in real interest rates (difference between interest rate & nominal inflation), as nominal inflation is increasing and interest rates are unchanged.

• Downward sloping curve as short term inflation expectations are higher