Here the term (E tπ t+1 – π*) denotes the difference between expected inflation and its steady state value, in our case below but close to 2%: if inflation expectations exceed the objective, the central bank – all other things being equal – is likely to raise its policy rate. A second factor that influences the policy stance is monetary conditions.
If the volume of money and credit that is created by financial intermediaries exceeds a trend that is consistent with price stability in the long run, the central bank is also expected to increase its policy rate, because excess money and credit creation can herald risks to price stability. In this simple policy rule, excess money and credit growth is denoted by mt.