According to the Taylor rule, if there is no unemployment gap and
A) if inﬂation rises to 4 percent, the Fed should raise its targeted interest rate to 7 percent.
B) when real GDP is equal to potential GDP and inﬂation is equal to its target of 4 percent, the Fed's targeted interest rate should be kept at 2 percent.
C) if inﬂation falls by 1 percentage point below its target of 2 percent, then the Fed should raise the real federal funds rate by one-half a percentage point.
D) all of these are appropriate Fed actions.

Question

Quizplus · Accepted Answer

CThe Taylor rule suggests that the Federal Reserve should adjust its target interest rate in response to deviations of actual inflation from its target level and of actual GDP from potential GDP. In choice A, if inflation rises to 4 percent and there is no unemployment gap (meaning the economy is at potential GDP), the Taylor rule suggests increasing the target interest rate, typically by more than the increase in inflation to cool down the economy. Choice C is also correct because, according to the Taylor rule, if inflation is 1 percentage point below its target, the Fed should adjust the real federal funds rate, in this case by increasing it to counteract the lower inflation, aiming to bring inflation back to its target. Choices B and D do not accurately reflect the Taylor rule's guidance for setting interest rates.

According to the Taylor Rule, If There Is No Unemployment