Question

If the Federal Reserve tries to target inflation near 2%, the inflation rate is 2.1%, and output is 4% below potential GDP, the target federal funds rate according to the Taylor rule is

Answer 1

Answer:

0.95%

Explanation:

Taylor's rule formula is as follow:

Target rate = Neutral rate + 0.5 x (Expected GDP growth rate - Long-term GDP growth rate) + 0.5 x (Expected Inflation rate - Target inflation rate)

The neutral rate is not given in the question. So let's assume that neutral rate is = 3%

--> Target rate = 3% + 0.5 x (-4%) + 0.5 x (2% - 2.1%)

--> Target rate = 1% - 0.05% =  0.95%