Question

Assume that we currently have an inflation rate of​ 1%, a nominal federal funds rate of​ 2% and a real federal funds rate of​ 1%. Now assume that we expect inflation to increase to 3​ %. With a​ 3% inflation rate it is determined that the real federal funds rate should be​ 3%, so in accordance to the Taylor​ rule, what should the nominal federal funds rate be changed​ to?

Answer 1

Answer:

The nominal federal funds rate be changed​ to 3%

Explanation:

Hi, in order to find the new nominal federal fund rate, we have to use the following equation.

$I=R^{*} +PI+0.5(PI-PI^{*} )$

Where:

I = Nominal fed funds rate (what we are looking for)

R*=Real federal funds rate (changed from 1% to 3%, we use 3%)

PI= Rate of inflation (current inflation, in our case, 1%)

PI*=Target inflation (expected inflation, 3%)

Everything should look like this.

I = 3% + 1% + 0.5(1% - 3%)

I = 4% - 0.5(-2%)

I = 4% - 1%

I = 3%

So the nominal federal funds rate should be 3% under this problem´s conditions.

Best of luck.