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

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  • Luhan, Wolfgang J.
  • Scharler, Johann

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 infl ation rate fluctuates around the inflation target if the computerized central bank obeys the Taylor principle. If the Taylor principle is violated, then the average infl ation 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 infl ation rate is only observed ex post.

Suggested Citation

  • Luhan, Wolfgang J. & Scharler, Johann, 2013. "Monetary Policy, Inflation Illusion and the Taylor Principle – An Experimental Study," Ruhr Economic Papers 402, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    • Handle: RePEc:zbw:rwirep:402
    DOI: 10.4419/86788457
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    More about this item

    Keywords

    Taylor principle; interest rate rule; inflation illusion; laboratory experiment;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General

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