Question

According to the Taylor rule, what is the federal funds target rate under the following conditions?

-Equilibrium real federal funds rate equals 4%

-Target rate of inflation equals 4%

-Current inflation rate equals 3%

Real GDP is 1% below potantial real GDP

The federal funds target rate equals _%(rounded answer to two decial places.)

Answer 1

Answer:

6%

Explanation:

According to the Taylor rule,

it = pt + rt* + 0.5 ( pt - pt*) + 0.5 ( yt - yt')

where it = target rate = (To be found out in the question)

pt = rate of inflation ( = 3%), rt* = real Fed funds rate( = 4%)

pt* = target inflation(= 4%)

yt - yt' = difference between real GDP and potential GDP ( = -1%)

Therefore, it = 3 + 4 + 0.5( 3% - 4%) + 0.5 ( -1%)

= 6%