According to the Taylor rule, if real GDP rises by 1 percent above potential GDP, the Fed should raise:
A) The supply of money by 10 percent
B) The velocity of money by 10 percent
C) The natural rate of unemployment from 4 percent to 5 percent
D) The Federal funds rate, relative to the current inflation rate, by 0.5 percent

Question

Quizplus · Accepted Answer

According to the Taylor rule, if real GDP rises by 1 percent above potential GDP, the Fed should raise the Federal funds rate, relative to the current inflation rate, by 0.5 percent. This is because an increase in real GDP can lead to higher inflation rates, and the Fed can use the interest rate to slow down economic growth and prevent inflation from rising too rapidly. Choices A and B are incorrect because increasing the supply or velocity of money can lead to higher inflation rates, which is the opposite of the desired outcome in this scenario. Choice C is incorrect because there is no direct relationship between the natural rate of unemployment and the Taylor rule.

According to the Taylor Rule, If Real GDP Rises by 1