Given the following formula for the Taylor rule: ?Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap) If output in the economy were to fall by an additional one percent below potential, the target federal funds rate would: ?

Question

Given the following formula for the Taylor rule: ?Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap) If output in the economy were to fall by an additional one percent below potential, the target federal funds rate would: ?

Quizplus · Accepted Answer

The output gap in the Taylor rule formula represents the difference between actual and potential output. If output falls by an additional one percent below potential, the output gap increases negatively by one percent. According to the formula, this would affect the target federal funds rate by ½(output gap), meaning the rate would decrease by 0.5%.

Given the Following Formula for the Taylor Rule: ?Target Federal