Suppose the Bank of Canada uses the Taylor rule to set the overnight loans rate.If the inflation rate is 3 percent, and the output gap is 0 percent, then the Taylor rule sets the overnight rate equal to

Question

Quizplus · Accepted Answer

According to the Taylor rule, the nominal federal funds rate should be equal to the sum of the equilibrium real federal funds rate, expected inflation rate, and one-half of the difference between actual output and potential output. The equation for the Taylor rule is:
i = r + π + 0.5(y - y*)
where:
i = nominal federal funds rate
r = equilibrium real federal funds rate
π = expected inflation rate
y = actual output
y* = potential output
Given that the inflation rate is 3 percent and the output gap is 0 percent, we can assume that the expected inflation rate is also 3 percent. Let's assume that the equilibrium real federal funds rate is 2 percent. Therefore, applying the Taylor rule, we get:
i = 2 + 3 + 0.5(0 - 0) = 5.5%
Therefore, the overnight rate set by the Bank of Canada using the Taylor rule would be 5.5 percent.

Suppose the Bank of Canada Uses the Taylor Rule to Set