Suppose the federal funds rate is 6 percent.If the output gap increases by 2 percentage points and the weight on output gap is 0.6, by how much should the federal funds rate increase according to the Taylor rule if all other variables remain unchanged?
A)It should increase by 0.4 percentage points.
B)It should increase by 0.6 percentage points.
C)It should increase by 2 percentage points.
D)It should increase by 1.2 percentage points.

Question

Suppose the federal funds rate is 6 percent.If the output gap increases by 2 percentage points and the weight on output gap is 0.6, by how much should the federal funds rate increase according to the Taylor rule if all other variables remain unchanged?​
A)It should increase by 0.4 percentage points.
B)It should increase by 0.6 percentage points.
C)It should increase by 2 percentage points.
D)It should increase by 1.2 percentage points.

Quizplus · Accepted Answer

According to the Taylor rule, the federal funds rate should increase by 0.5 times the change in the output gap plus 1.5 times the difference between inflation and the Fed's target inflation rate. Since all other variables are unchanged, we can assume that there is no change in inflation. Therefore, the increase in the federal funds rate should be:
0.5 x 2 + 1.5 x 0 = 1
So, the federal funds rate should increase by 1.2 percentage points (since it currently stands at 6 percent). Therefore, the correct answer is D.

Suppose the Federal Funds Rate Is 6 Percent