According to the Taylor rule, if inflation equals 3 percent and there is an expansionary gap equal to 3 percent of potential output, the Fed will set a real interest rate of ________ percent and a nominal interest rate of ________ percent.

Question

Quizplus · Accepted Answer

According to the Taylor rule, r = 0.01 + 0.5 (output gap as a percent of potential GDP)+ 0.5 (inflation rate). Substituting into the equation r = 0.01 + 0.5 (0.03)+ 0.5 (0.03)= 0.01 + 0.015 + 0.015 = 0.04, or 4 percent. Nominal interest rate = real interest rate + the inflation rate. So the nominal interest rate here is 7 percent (4 percent + 3 percent).

According to the Taylor Rule, If Inflation Equals 3 Percent