Monetary policy reaction function
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The Monetary Policy Reaction Function (MPRF) is the upward-sloping relationship between the inflation rate and the unemployment rate. When the inflation rate rises, a central bank wishing to fight inflation will raise interest rates to reduce output and thus increase the unemployment rate. The MPRF is a function of the Taylor Rule, the Investment-Spending Curve (IS Curve) and Okun's Law
The MPRF has the equation:
u = u0 + Φ(π - πt)
Where Φ is a parameter that tells us how much unemployment rises when the central bank raises the real interest rate r because it thinks that inflation is too high and needs to be reduced.
The Slope of the MPRF is: 1/Φ
The MPRF is used hand in hand with the Phillips Curve to determine the effects of economic policy. This framework illustrates equilibrium levels of the unemployment rate and the inflation rate in a sticky-price model.
