According to the Taylor rule, when the economy has a zero-unemployment gap and the inﬂation rate is equal to its target rate of 2 percent, the Fed's targeted interest rate should be
A) 2 percent, and this implies a real interest rate of 0 percent.
B) 2 percent, and this implies a real interest rate of 4 percent.
C) 4 percent, and this implies a real interest rate of 2 percent.
D) 4 percent, and this implies a real interest rate of 4 percent.

Question

Quizplus · Accepted Answer

The Taylor rule suggests that the Federal Reserve's targeted interest rate should be set at a level that is consistent with the sum of the current inflation rate and an equilibrium real interest rate (often considered to be around 2 percent) when the economy is at full employment and inflation is at its target level. Since the inflation rate is 2 percent and the equilibrium real interest rate is typically 2 percent, adding these together gives a targeted interest rate of 4 percent, implying a real interest rate of 2 percent.

According to the Taylor Rule, When the Economy Has a Zero-Unemployment