Assume the central bank's announced inflation target is 2%, output is 2% below the full-employment level, and the Taylor rule suggests that the central bank sets the nominal interest rate at 4.5%.What is most likely the current inflation rate?
A)3)0%
B)3)6%
C)4)0%
D)4)5%
E)6)0%

Question

Quizplus · Accepted Answer

According to the Taylor rule, the nominal interest rate is set by adding the target inflation rate to the difference between the actual inflation rate and the target rate, and adding the output gap multiplied by a coefficient (usually around 0.5). In this case, the output gap is -2%, so the nominal interest rate should be set at:

4.5% + (2% - 2%) + (-2% x 0.5) = 3%

Therefore, if the central bank is following the Taylor rule and aiming for the 2% inflation target while output is below full-employment levels, the current inflation rate is likely around 3.6%, which is above the target rate but within the typical range of acceptable inflation.

Assume the Central Bank's Announced Inflation Target Is 2%, Output