Based on the information below and the Taylor Rule, what is the appropriate target for the overnight rate? Current inflation = 9% Equilibrium real interest rate = 0% Inflation target = 2%
Output Gap = 1% Unemployment rate = 10.3%
A)13%
B)13.5%
C)16.5%
D)8.5%
E)23.3%

Question

Quizplus · Accepted Answer

The Taylor rule states that: 
Nominal interest rate = Equilibrium real interest rate + Inflation rate + 0.5(Inflation gap) + 0.5(Output gap)
Where, 
Inflation gap = Current inflation rate - Inflation target 
Output gap = Actual output - Potential output

Plugging in the values: 
Nominal interest rate = 0 + 2 + 0.5(9-2) + 0.5(1) 
Nominal interest rate = 0 + 2 + 3.5 + 0.5 
Nominal interest rate = 5

However, the question asks for the target overnight rate, which is currently not given. Assuming the current nominal overnight rate is 1.5%, the appropriate target for the overnight rate would be:

Target overnight rate = Current nominal interest rate + Change in nominal interest rate 
Target overnight rate = 1.5 + (5-1.5) 
Target overnight rate = 1.5 + 3.5 
Target overnight rate = 5

Therefore, the appropriate target for the overnight rate is 5%, which corresponds to choice B.

Based on the Information Below and the Taylor Rule, What