If the Fed's policy reaction function equals r = .02 + π, where r is the real interest rate and π is the inflation rate. When the inflation rate is zero, then the real interest rate will be:
A)set to equal 2 percent.
B) below the target value for the real interest rate.
C)set to equal zero.
D)set to equal 4 percent.

Question

If the Fed's policy reaction function equals r = .02 + π, where r is the real interest rate and π is the inflation rate. When the inflation rate is zero, then the real interest rate will be:
A)set to equal 2 percent.
B) below the target value for the real interest rate.
C)set to equal zero.
D)set to equal 4 percent.

Quizplus · Accepted Answer

According to the reaction rule, the Federal Reserve will set the real interest rate to whatever the rate of inflation is plus 2 percent. So in the absence of inflation, the real interest rate will be set at 2 percent.

If the Fed's Policy Reaction Function Equals R =