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

Wolfgang Luhan and Johann Scharler

No 402, Ruhr Economic Papers from RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen

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.

Keywords: Taylor principle; interest rate rule; inflation illusion; laboratory experiment (search for similar items in EconPapers)
JEL-codes: C90 E30 E52 (search for similar items in EconPapers)
Date: 2013
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Working Paper: Monetary Policy, Inflation Illusion and the Taylor Principle: An Experimental Study (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:rwirep:402

DOI: 10.4419/86788457

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