According to the Taylor rule, when real GDP is equal to potential GDP and inflation is equal to its target rate of 2 percent, the Federal fund rate should:
A) Be increased by 10 percent
B) Be decreased by 10 percent
C) Remain at about 4 percent
D) Remain at about 8 percent

Question

Quizplus · Accepted Answer

According to the Taylor rule, when real GDP is equal to potential GDP and inflation is equal to its target rate of 2 percent, the Federal fund rate should remain at about 4 percent. This is because the Taylor Rule uses the difference between actual and potential output, as well as the difference between actual and target inflation, to determine the appropriate monetary policy stance. When both of these variables are at their target levels, the rule suggests that the policy rate should be set at its "neutral" level, which is estimated to be around 4 percent. Therefore, choice C is the best answer.

According to the Taylor Rule, When Real GDP Is Equal