Suppose the equilibrium real federal funds rate is 2 percent,the target rate of inflation is 2 percent,the current inflation rate is 4 percent,and real GDP is 2 percent above potential real GDP.If the weights for the inflation gap and the output gap are both 1/2,then according to the Taylor rule the federal funds target rate equals

Question

Quizplus · Accepted Answer

According to the Taylor rule, the federal funds target rate can be calculated as:

Federal Funds Target Rate = Equilibrium Real Funds Rate + (Inflation Gap * Inflation Weight) + (Output Gap * Output Weight)

Here, Equilibrium Real Funds Rate = 2%, Inflation Weight = Output Weight = 1/2

Inflation Gap = Current Inflation Rate - Target Inflation Rate = 4% - 2% = 2%

Output Gap = Real GDP - Potential Real GDP = 2% - 0% = 2%

Plugging in these values in the Taylor rule equation, we get:

Federal Funds Target Rate = 2% + (2% * 1/2) + (2% * 1/2) = 8%

Therefore, the answer is C) 8 percent.

Suppose the Equilibrium Real Federal Funds Rate Is 2 Percent,the