Assume a central bank announced a zero percent inflation target.If the current inflation rate is 2.4%, and output is at the full-employment level, at what level should the central bank set the nominal interest rate according to the Taylor rule?

Question

Quizplus · Accepted Answer

The Taylor rule formula is: Nominal Interest Rate = Real Interest Rate + Current Inflation + 0.5(Inflation Gap) + 0.5(Output Gap). Assuming a real interest rate of 2% (a common assumption) and aiming for a 0% inflation target while the current inflation is 2.4% (inflation gap of 2.4%) and output is at full employment (output gap of 0%), the calculation is: Nominal Interest Rate = 2% + 2.4% + 0.5(2.4% - 0%) + 0.5(0%) = 2% + 2.4% + 1.2% = 5.6%, which rounds to approximately 6%.

Assume a Central Bank Announced a Zero Percent Inflation Target