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True or false: If actual inflation rises one percent above target and the central bank...

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lilylee | Student, College Freshman | Salutatorian

Posted July 27, 2013 at 3:36 PM via web

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True or false:

If actual inflation rises one percent above target and the central bank raises the actual funds rate by one percent then according to the Taylor rule, the central bank is being hawkish.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted July 27, 2013 at 3:55 PM (Answer #1)

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This statement is false.  In such a situation, the central bank would not be acting as an inflation hawk.

According to the Taylor rule, this central bank would actually be somewhat dovish.  Taylor’s rule states that central banks should try hard to combat inflation.  Specifically, it states that they should raise the nominal interest rates by more than the amount that the rate of inflation has risen.  In other words, if the rate of inflation goes up by 1%, the central government should increase the interest rates by more than 1%.  In the situation stated in this question, the central government does not do this.  Instead, it only raises the interest rate by the exact amount that the rate of inflation increased.

Since the central bank is not raising the interest rate by more than the rate of inflation, it could not be called hawkish in this situation.  Therefore, the statement is false.

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