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Monetary Policy, Inflation Illusion and the Taylor Principle – An Experimental Study

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  • Wolfgang J. Luhan

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  • Johann Scharler

Abstract

We develop a simple experimental setting to evaluate the role of the Taylor principle, which holds that the nominal interest rate has to respond more than one-for-one to fluctuations in the inflation rate. In our setting, the average inflation rate fluctuates around the inflation target if the computerized central bank obeys the Taylor principle. If the Taylor principle is violated, then the average inflation rate persistently deviates from the target. We find that these deviations from the target are less pronounced, if inflation rates cannot be as readily observed as nominal interest rates. This result is consistent with the interpretation that subjects underestimate the influence of inflation on the real return to savings if the inflation rate is only observed ex post.

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Bibliographic Info

Paper provided by Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen in its series Ruhr Economic Papers with number 0402.

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Length: 32 pages
Date of creation: Feb 2013
Date of revision:
Handle: RePEc:rwi:repape:0402

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Keywords: Taylor principle; interest rate rule; inflation illusion; laboratory experiment;

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