If the central bank did not follow the Taylor principle so that the real interest rate fell when inflation rose, ________.
A) inflation would increase
B) the nominal interest rate would not change
C) expected inflation would be equal to zero
D) output would remain unchanged

Question

Quizplus · Accepted Answer

If the real interest rate falls when inflation rises, it means that the central bank is not responding adequately to the increase in inflation. This could lead to expectations of higher inflation in the future, causing people to demand higher wages and leading to a further increase in inflation. Therefore, inflation would increase in this scenario.

If the Central Bank Did Not Follow the Taylor Principle