Suppose the inflation rate target is zero and the long-run federal funds target is also zero.Calculate the federal funds rate if the current inflation rate is 5 percent and real output is 4.5 percent below the trend output level.
A) 2.25 percent
B) 0.5 percent
C) 5.25 percent
D) 0.25 percent

Question

Quizplus · Accepted Answer

Given the inflation rate is 5 percent and the output gap is -4.5 percent, the Taylor rule, which adjusts the federal funds rate based on current economic conditions relative to inflation and output goals, suggests an increase in the rate to counteract inflation. The formula typically involves adjusting for both the inflation gap (current inflation minus target inflation) and the output gap. Here, with a 5 percent inflation rate (far from the 0 percent target) and a negative output gap, the rate adjustment would aim to curb inflation, leading to a higher federal funds rate, which aligns with option C, 5.25 percent, indicating a direct response to the high inflation.

Suppose the Inflation Rate Target Is Zero and the Long-Run