According to the Taylor rule, when real GDP is equal to potential GDP, and the inflation rate is equal to its target rate of two percent, the Federal funds rate should be:
A) 2 percent and this implies a real interest rate of 0 percent
B) 2 percent and this implies a real interest rate of 4 percent
C) 4 percent and this implies a real interest rate of 2 percent
D) 4 percent and this implies a real interest rate of 4 percent

Question

Quizplus · Accepted Answer

According to the Taylor rule, when real GDP equals potential GDP and inflation is at its target, the nominal interest rate should be the sum of the real interest rate and the inflation rate. Typically, the real interest rate is assumed to be 2%, so the nominal rate would be 4%, implying a real interest rate of 2%.

According to the Taylor Rule, When Real GDP Is Equal