Suppose the current real federal funds rate in the economy is 1.5%, the current inflation rate is 3.0%, the Federal Reserve's target inflation rate is 2.0%, and the output gap is 1.0%. The Taylor Rule would suggest that the Federal Reserve's target federal funds rate should be

Question

Quizplus · Accepted Answer

The Taylor Rule formula is: Federal Funds Target Rate = Neutral Rate + 1.5(Inflation - Inflation Target) + 0.5(Output Gap). Assuming a neutral rate of 2% (a common assumption), the calculation would be: 2% + 1.5(3% - 2%) + 0.5(1%) = 2% + 1.5% + 0.5% = 4%. Since the current real federal funds rate is 1.5%, the Taylor Rule suggests it should be much higher, at 4%.

Suppose the Current Real Federal Funds Rate in the Economy