Question

Does the Taylor Rule put a higher weight on resolving the unemployment gap or the inflation gap? Explain.

Short answer

The Taylor rule puts a higher weight on resolving the inflation gap. It suggests that the interest rates must be raised when the inflation rates are higher.

Step-by-step solution

Step 1. The Taylor rule

The Taylor rule is used to predict whether the economy will be experiencing deflationary tendencies or inflationary tendencies to guide the central bank to take the necessary actions. The Taylor rule is defined as:

The interest rate of 2 percent added to the current rate of inflation and 1/2 times the inflation gap subtracted by 1.0 times the unemployment gap.

The Taylor rule suggests that the interest rates must be altered to influence the inflationary tendencies to achieve economic stability. Therefore, it gives more weightage to resolving the inflation gap.