Question

Using the Taylor rule, if inflation is 1 percent, desired inflation is 2 percent, and output is 2 percentage points below potential, the Fed should target a federal funds rate of:

Answer 1

Answer:

1.5%

Step-by-step explanation:

According to the Taylor rule, the federal funds rate targeted by the Fed is:

$FFR = 2+AI+0.5*(AI-DI)+0.5PD$

Where AI is the actual inflation (1%), DI is the desired inflation (2%) and PD is the deviation from potential (2%):

$FFR = 2+1+0.5*(1-2)+0.5*(-2)\\FFR=1.5\%$

The Fed should target a federal funds rate of 1.5%.