Assume that the Bank of Canada has a target inflation rate of 2% and that the values for how much the nominal target overnight rate responds to a deviation of inflation from its target,g,and how much the nominal target overnight rate responds to real GDP,h,are both 0.5.According to the Taylor rule,if inflation increases by 6%,the real interest rate will increase by
A) 3%.
B) 4%.
C) 6%.
D) 9%.

Question

Quizplus · Accepted Answer

According to the Taylor rule, the nominal interest rate should increase by 1.5 times the inflation deviation. With a 6% increase in inflation, the nominal rate increases by 1.5 * 6% = 9%. Since the real interest rate is the nominal rate minus inflation, the real interest rate increases by 9% - 6% = 3%.

Assume That the Bank of Canada Has a Target Inflation