CFA Practice Question

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CFA Practice Question

According to the Taylor rule, the neutral policy rate is the short-term real interest rate plus the inflation rate when ______

I. inflation is close to zero.
II. inflation is equal to the targeted level.
III. the output gap is close to zero.
IV. the unemployment rate is close to zero.
Correct Answer: II and III

The Taylor rule does not suggest that central banks should try to set their policy rates to be close to the neutral policy rate. Central banks should adjust their policy rates based on inflation expectations and the economy'??s output gap. If other factors are equal, when inflation is above (below) the targeted level, the policy rate should be above (below) the neutral rate; when the output gap is positive (negative), the policy rate should also be above (below) the neutral rate.

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