You are the Chair of the Federal Reserve Bank of the United States. The neutral rate of interest is 2%, the inflation rate is 0.75%, and the output gap is -1%. Using the Fed's rule of thumb, what is the appropriate new nominal federal funds rate that you should set for the economy?

Question

Quizplus · Accepted Answer

The appropriate new nominal federal funds rate can be calculated using the Taylor rule formula, which suggests adjusting the nominal interest rate based on the current inflation rate and the deviation of actual economic output from its potential level. According to the Fed's rule of thumb, the formula is: nominal federal funds rate = neutral rate + current inflation + 0.5 * (current inflation - target inflation) + 0.5 * output gap. Given the neutral rate of 2%, inflation of 0.75%, an output gap of -1%, and assuming a target inflation of 2% (not explicitly stated but commonly targeted by central banks), the calculation is: 2% + 0.75% + 0.5 * (0.75% - 2%) + 0.5 * (-1%) = 1.125%.

You Are the Chair of the Federal Reserve Bank of the United