CFA Level I · CFA Level I Exam · Monetary Policy
A central bank targets an inflation rate of 2%, and actual inflation is 4% with the economy growing above potential. Following a Taylor-rule-style approach, the central bank would most likely:
The central bank would most likely raise the policy rate. Inflation exceeds the 2% target and growth is above potential, and a Taylor-style rule responds to both gaps with a higher rate that slows demand and brings inflation back toward target.
- Araise the policy rate to slow demandCorrect
- Blower the policy rate to support growth
- Ckeep the policy rate unchanged to preserve credibility
Explanation
Inflation above target and output above potential both imply that a rule-based approach calls for a higher policy rate to cool demand. Lowering rates would add stimulus and worsen inflation. Holding the rate fixed ignores both gaps.
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