According to the Taylor rule, if inflation rises by 1 percent above its target of 2 percent, the Fed should:
A) Lower the real Federal funds rate by 0.5 percent
B) Raise the real Federal funds rate by 0.5 percent
C) Lower the money supply by 5 percent
D) Raise the money supply by 5 percent

Question

Quizplus · Accepted Answer

According to the Taylor rule, if inflation rises by 1 percent above its target of 2 percent, the Fed should raise the real Federal funds rate by 0.5 percent. This increase in the real interest rate will help reduce aggregate demand and thus slow down inflation. Lowering the money supply or raising the money supply could have unintended consequences for the economy beyond just controlling inflation. Therefore, the best choice is to raise the real Federal funds rate.

According to the Taylor Rule, If Inflation Rises by 1