Suppose the equilibrium real interest rate is 2 per cent per year, inflation is 2.5 per cent and the output gap is 1 per cent. Using the Taylor rule, what is the cash rate?

Question

Quizplus · Accepted Answer

The Taylor rule formula is: Cash Rate = Equilibrium Real Interest Rate + Inflation + 0.5(Output Gap) + 0.5(Inflation Gap). Here, Inflation Gap = Inflation - Target Inflation (assuming target is 2%). So, Cash Rate = 2% + 2.5% + 0.5(1%) + 0.5(0.5%) = 5.25%.

Suppose the Equilibrium Real Interest Rate Is 2 Per Cent