How Would The Implementation Of A Taylor Rule-based Monetary Policy Framework, Assuming A 2% Inflation Target And A 4% Equilibrium Real Interest Rate, Affect The Slope Of The Yield Curve In A Small Open Economy With A Floating Exchange Rate Regime, And Would This Impact Be Mitigated Or Exacerbated By The Presence Of A Term Premium In The Long-term Interest Rate?

The implementation of a Taylor rule-based monetary policy framework in a small open economy with a floating exchange rate regime would likely steepen the yield curve. This is because the Taylor rule increases short-term interest rates in response to inflation above the target, while long-term rates, influenced by expectations and the term premium, may not rise as sharply. The presence of a term premium, which is typically positive, would exacerbate this steepening effect. The term premium, by keeping long-term rates higher, amplifies the slope when short-term rates increase. Thus, the yield curve becomes steeper under the Taylor rule, and the term premium intensifies this effect.