If the current rate of inflation is 4 percent, using the values suggested by Professor Taylor, the Taylor rule predicts a federal funds rate of ________ percent.
A) 1
B) 4.5
C) 3
D) 4
E) 0.5

Question

If the current rate of inflation is 4 percent, using the values suggested by Professor Taylor,  the Taylor rule predicts a federal funds rate of ________ percent.
A) 1 
B) 4.5 
C) 3 
D) 4 
E) 0.5

Quizplus · Accepted Answer

According to the Taylor rule, the federal funds rate should be equal to the sum of the inflation rate, the equilibrium real federal funds rate (which is currently estimated to be 2 percent), and one-half of the difference between the actual and target inflation rates (which is currently 1 percent, since the target inflation rate is 2 percent). Therefore, the federal funds rate should be 3 percent (4% inflation rate + 2% equilibrium real federal funds rate + 0.5*(2% target inflation rate - 4% actual inflation rate) = 3%).

If the Current Rate of Inflation Is 4 Percent, Using