According to the Taylor rule, the Reserve Bank ____ the real interest rate as the output gap increases and ____ the real interest rate as the inflation rate increases.Group of answer choiceslowers; lowerslowers; raisesraises; lowersraises; raiseslowers; does not change
Question
According to the Taylor rule, the Reserve Bank ____ the real interest rate as the output gap increases and ____ the real interest rate as the inflation rate increases.Group of answer choiceslowers; lowerslowers; raisesraises; lowersraises; raiseslowers; does not change
Solution
The Taylor rule is a guideline for how central banks should alter interest rates in response to changes in economic conditions.
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As the output gap increases, the Taylor rule suggests that the Reserve Bank should lower the real interest rate. The output gap is the difference between the actual output of an economy and the maximum potential output of an economy. When the output gap is positive, it means the economy is producing above its potential, which could lead to inflation. To counteract this, the Reserve Bank would lower the real interest rate to slow down economic activity.
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As the inflation rate increases, the Taylor rule suggests that the Reserve Bank should raise the real interest rate. Higher inflation means that prices are rising, and to keep the economy from overheating, the Reserve Bank would raise the real interest rate to slow down economic activity.
So, the correct answer is: lowers; raises.
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