Question #13
Reading: Reading 39 Economics and Investment Markets
PDF File: Reading 39 Economics and Investment Markets.pdf
Page: 5
Status: Correct
Correct Answer: B
Part of Context Group: Q13-16
First in Group
Shared Context
Question
Assuming the Taylor rule holds, Professor Brady's statement on the correlation of interest rates with macroeconomic fundamentals is most likely:
Answer Choices:
A. correct
B. incorrect in respect of the correlation of interest rates with inflation
C. incorrect in respect of the correlation of interest rates with GDP growth
Explanation
intertemporal rate of substitution = mt =
marginal utility of delayed consumption
marginal utility of present consumption
= 0.95
1
R =
−1 =
−1
1
E(mt)
1
0.95
The Taylor rule links central bank interest rates to inflation and GDP growth:
r = Rn + π + 0.5(π – π*) + 0.5(y – y*)
where:
r = central bank policy rate implied by the Taylor rule
Rn = neutral real policy interest rate
π = current inflation rate
π* = central bank's target inflation rate
y = log of current level of GDP
y* = log of central bank's target (sustainable) GDP
If inflation and GDP rise, central bank policy rates would be expected to rise if the Taylor
rule holds.