Suppose that the inflation rate is 3 percent and the output gap is -1 percent. Assuming that the equilibrium real interest rate is 2 percent, what target should the Fed set for the federal funds rate, if the Taylor rule is used?
A) 5 percent
B) 6 percent
C) 4 percent
D) 1 percent

Question

Quizplus · Accepted Answer

The Taylor rule formula is: Federal Funds Rate = Equilibrium Real Interest Rate + Inflation Rate + 0.5(Output Gap) + 0.5(Inflation Gap). Here, Inflation Gap is zero (assuming target inflation is 3%). So, 2% + 3% + 0.5(-1%) = 5%.

Suppose That the Inflation Rate Is 3 Percent and the Output