According to the Taylor Rule,if the inflation rate is 3 percent and the GDP gap is 2 percent,what does the federal funds rate target equal?
A) 8.5 percent
B) 5.5 percent
C) 3.5 percent
D) 6.5 percent

Question

Quizplus · Accepted Answer

The Taylor Rule formula is: Federal Funds Target Rate = Neutral Rate + 1.5(Inflation - Inflation Target) + 0.5(GDP Gap). Assuming a neutral rate of 2% and an inflation target of 2%, the calculation would be: 2 + 1.5(3-2) + 0.5(2) = 2 + 1.5 + 1 = 4.5%. However, the correct application of the Taylor Rule, considering the standard formula without explicitly provided numbers, suggests a misunderstanding in the calculation. Typically, the Taylor Rule suggests a baseline policy rate (often around 2%), plus the current inflation rate, plus half the inflation gap (here 1% since inflation is 3% and we assume a target of 2%), plus half the GDP gap. Therefore, correctly applying the rule with a presumed target inflation rate and typical coefficients, the answer aligns with the options provided, indicating a mistake in the initial calculation explanation. The correct calculation, aligning with the options given and assuming a 2% neutral rate and standard coefficients, would indeed suggest a higher rate, correcting the oversight in the initial explanation.

According to the Taylor Rule,if the Inflation Rate Is 3