If the Federal Reserve adheres strictly to the Taylor rule, it will
A) lower the target federal funds rate when the economy starts to overheat.
B) keep the target federal funds rate constant, regardless of evolving economic conditions.
C) increase the target federal funds rate when there is concern about inflation and lower it when there is concern about recessions.
D) decrease the target federal funds rate when the government runs an expansionary fiscal policy.

Question

Quizplus · Accepted Answer

The Taylor rule suggests that the Federal Reserve should increase or decrease the target federal funds rate based on the current inflation rate and the output gap (difference between actual GDP and potential GDP). If inflation is above the target level and the output gap is positive, the Fed should increase the target rate to cool down the economy and prevent further inflation. Conversely, if inflation is below the target level and the output gap is negative, the Fed should lower the target rate to stimulate the economy and prevent a recession. Therefore, choice C is the correct answer.

If the Federal Reserve Adheres Strictly to the Taylor Rule