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starbucks4ever (89.25)

He is providing interest rate guidance for central banks. But he doesn't know how compound interest is calculated.



June 01, 2009 – Comments (2)

John B. Taylor could well benefit from a crash course in Precalculus, where they discuss stuff like exponential functions. In this paper, he writes:

"A 100 per cent increase in the price level means about 10 per cent inflation for 10 years."

Had John B. Taylor consulted his math textbook, he would have realized that dividing 100% by 10 years is NOT how you calculate the annual inflation rate. Or else, for the mathematically challenged, there is a simple rule-of-thumb formula which they give in Economics 101 textbooks: take 72 and divide it by the number of years to get the approximate rate of inflation (granted, it begins to fail in a hyperinflationary environment). Apparently, the mystery of compound interest is still a "terra incognita" for the former Under Secretary of the Treasury and renowned expert on monetary policy who is providing guidance to central banks on how to determine interest rates. Stanford University should consider offering its professor a free semester in Undergraduate Math to make sure that central banks get the right advise. 

2 Comments – Post Your Own

#1) On June 01, 2009 at 4:45 PM, portefeuille (98.32) wrote:

solve (1+x)^10 = 2 for x

x = 2^(1/10) - 1 = ca. 0.7177 --> ca. 7.2 % (your 72/10)

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#2) On June 01, 2009 at 6:42 PM, starbucks4ever (89.25) wrote:

Or x=(ln2)/10 = 6.9% for continuous compounding. It would be interesting, BTW, to check which one of the two is reported as the official CPI, although for low inflation, the difference is not that large. Will somebody email this link to John B. Taylor, Ph.D? :) 

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