The Taylor rule
The rule sets the policy rate from the inflation gap and the output gap: i = r* + π + 0.5(π − π*) + 0.5ỹ. The slope on inflation is 1.5, steeper than the 45° line i = π. That extra steepness is the Taylor principle, so the real rate rises with inflation.
Prescribed policy rate i3.0%
Implied real rate r = i − π 1.0%Inflation gap π − π* +0.0%
Inflation π2.0%
Inflation target π*2.0%
Output gap ỹ+0.0%
Neutral real rate r*1.0%
Because the slope (1.5) exceeds 1, the implied real rate r = i − π = 1.0% rises when inflation rises. A higher real rate cools demand, which is how the rule stabilises inflation.