Which rule states that the government should adjust interest rates based on inflation levels?

The Taylor Rule is a monetary policy principle that provides a guideline for setting interest rates based on economic conditions, specifically targeting both inflation and economic output. It suggests that the central bank, such as the Federal Reserve in the United States, should increase interest rates when inflation is above a certain target level or when the economy is growing rapidly, and decrease rates when inflation is below target or when the economy is slowing down.

This rule is significant because it helps to stabilize the economy by adjusting the cost of borrowing money in alignment with inflation rates. It reflects the relationship between inflation, output, and interest rates, making it a critical tool for managing economic stability.

In contrast, the other choices reflect different concepts in economic policy. Monetary Policy is the broader category involving the management of money supply and interest rates, but it does not specifically dictate how to adjust rates based on inflation. Fiscal Policy refers to government spending and taxation decisions, while Discretionary Policy encompasses decisions made on a case-by-case basis, without the systematic approach that the Taylor Rule advocates.

Thus, the Taylor Rule stands out as the specific guideline focused on adjusting interest rates in response to inflation levels, making it the correct choice.