Suppose the Fed has set the federal funds rate at 4.5 percent using the Taylor rule.If the inflation rate increases by 1 percentage point and the weight on inflation gap is 0.5, all other variables remain unchanged, the federal funds rate should
A)decrease to 3.5 percent.
B)decrease to 4 percent.
C)increase to 5.5 percent.
D)increase to 5 percent.

Question

Quizplus · Accepted Answer

The Taylor rule suggests that for every 1 percentage point increase in inflation, the federal funds rate should increase by 1.5 times the inflation rate increase if the weight on the inflation gap is 0.5. Therefore, a 1 percentage point increase in inflation would lead to a 0.5 percentage point increase in the federal funds rate, raising it from 4.5 percent to 5 percent.

Suppose the Fed Has Set the Federal Funds Rate at 4.5