Question

If the inflation rate target is​ 2%, the current inflation rate is​ 1%, and the output gap is minus​ 2%, then according to the Taylor​ rule, the nominal federal funds rate should be​ ________ percent. A. five B. three C. zero D. four E. none of the above

Answer 1

Answer:

E

Explanation:

According to the Taylor rule, the formula for finding nominal federal funds rate is given as

i = r* + pi + 0.5(pi - pi*) + 0.5(y - y*),

Where i is the nominal federal funds rate, r* is the real federal funds rate (taken as 2%), pi is the rate of inflation, pi* is the target inflation rate, y is the logarithm of real output and y* is the logarithm of potential output

Substituting values, we have;

i = 2 + 1 + 0.5(1-2) + 0.5(2)

i = 3.5%