CFA Practice Question

There are 136 practice questions for this study session.

CFA Practice Question

A country's neutral policy rate is 2.2%. The target inflation rate is 1.5%. If a central bank expects the inflation rate will be 2%, the central bank should set its policy rate to be ______ based on the Taylor rule.
A. 2.05%
B. 2.2%
C. 2.95%
Explanation: The short-term real interest rate is 0.7% (2.2% - 1.5%). The policy rate should be 0.7% + 1.5 x 2% - 0.5 x 1.5% = 2.95%

In general, when inflation is above (below) the targeted level, the policy rate should be above (below) the neutral rate. Out of these choices, only 2.95% is higher than the neutral rate of 2.2%.

User Contributed Comments 2

User Comment
sunday128 I think it was obvious for the need of a higher policy rate than 2.2% to curb excess inflation?
Amir1 Since inflation rate of 2% is above the target inflation rate of 1.5%, then the policy rate must be above the neutral rate of 2.2% and vice versa.
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