Using the Taylor rule, if inflation is 3 percent, desired inflation is 2 percent, and output is 2 percentage points above potential, the Fed should target a federal funds rate of:
A)6.5.
B)4.5.
C)3.5.
D)3.0.

Question

Quizplus · Accepted Answer

The Taylor rule formula is: Federal Funds Rate = Neutral Rate + 0.5*(Inflation Gap) + 0.5*(Output Gap). Assuming a neutral rate of 2%, the calculation is: 2% + 0.5*(3%-2%) + 0.5*(2%) = 6.5%.

Using the Taylor Rule, If Inflation Is 3 Percent, Desired