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 the inflation rate in the economy were to fall by 2% below the target inflation rate, 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 the inflation rate in the economy were to fall by 2% below the target inflation rate, the target federal funds rate would: ?

Quizplus · Accepted Answer

The Taylor rule formula indicates that the target federal funds rate adjusts based on the inflation gap and the output gap. A fall in the inflation rate by 2% below the target would decrease the target rate by 1% directly (half of the inflation gap, as per the formula) and by an additional 2% indirectly (the full amount of the inflation gap), totaling a 3% decrease.

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