# taylors rule

Taylor’s rule- this popped up in the practice questions and kind of scared me. do we need to know this? i didn’t see this come up anywhere in the curriculum. did i miss something here? I sincerely hope not.

Its in PM (economics of investment markets)… and yes, you should know it.

Here and at Level III.

yes and keep in mind that it includes inflation ( versus the old version that did not)

Removed from Econ though correct? It won’t be tested in PM. Why? Because it’s too plug and chug. CFAI likes to reallllllly make you think on PM questions, from a theoretical and logic based standpoint. ie likes to see if you really understand why things are the way they are.

Regarding PM, I wouldn’t sleep on the algorithms reading. They drive 75 percent of market trading currently according to CFAI.

It doesnt have to be plug and chug… It could more qualative requiring you to think. They could ask the impact of currency inflation if the output gap up or down, and if the inflation gap is up or down… I’ve seen various questions of that nature that doesnt even talk about taylor rule but are implicitly implying taylor rule.

Good point

But really, this is essentially plug and chug, right? Haven’t looked at this stuff in a while, but couldn’t you just write out the formula and see what happens when one of those elements increases or decreases? Worst case you could plug in reasonable numbers, too.

While I understand taylor rule well… I have a very mild understand how the policy rate links to everything else…So I could easily solve a taylor rule question with plug-chug, I missed the following question on which statement is more correct… and still don’t understand it.

Statement 1: The real value of currency is positively related to its neutral interest rate and inflation gap

Statement 2: The real value of currency is negatively related to output gap and the risk premium demanded by investors for investing in that currency

Statement 1 is correct because the real value of currency is positively related to output gap, inflation gap, and neutral real interest rate. But like you, I only know this from the formula, I don’t know exactly why.

Statement 2 is incorrect; Statement 1 is correct.

Real value of currency is positively related to output gap, inflation gap and neutral rate. It is negatively related to risk premium… Only statement 1 is correct. Not so chug and plug!

Looking only at the formula, I can only conclude 1 is the only correct answer.

Maybe I am missing something, but if you want, maybe you could point out the elements of the equation that suggest 2 is correct? I’m only seeing statement 1.

damn! I might as well not show up next saturday then haha

The way I look at it, real value of currency is positively related to real interest rate. That’s why according to IFR, you want to invest in the currency that has the highest real rate. Then, you break down real interest rate using Taylor Rule, you find that real interest rate is positively related to inflation gap, output gap, and neutral rate.

As for risk premium, larger risk premium means higher required rate of return which in turns decrease the real value of currency?

I change my mind, this wont be on the test… This wont be on the test…

Next!

APT, ex post IR, optimal Risk, macro, fundamental statistical factor model more likely. Lol.

if I fail PM tomorrow on CFAI Mock B. I will learn the Taylor Rule

My question still stands for you.

Well, I don’t know remember why I picked the 2nd statement as the correct statement. I think I was more than satisfied with the rest of the mock exam so I rushed this one. Perhaps my “intuition” thought the real rate was inversely related to the output, but I ignored the first statement.

Maybe iprofit4sure can give a more concrete example why he choose the 2nd statement!

Sounds like an easy fix for exam day, though!