Suppose the inflation rate target is zero and the long-run federal funds target is also zero.If the inflation rate is 4 percent and the output gap is ‒2 percent,the federal funds rate set by the Taylor rule is ________.
A) 5 percent
B) 6 percent
C) 2 percent
D) 8 percent

Question

Quizplus · Accepted Answer

The Taylor rule is:```i = \pi + r + \alpha_1 * (\pi - \pi^*) + \alpha_2 * (y - y_bar)```where:* i is the federal funds rate* \pi is the inflation rate* r is the long-run federal funds target* \pi^* is the inflation rate target* y is the output gap* y_bar is the natural rate of output* \alpha_1 and \alpha_2 are positive constantsIn this case, \pi^* = 0, r = 0, \pi = 4, and y = -2. Plugging these values into the Taylor rule, we get:```i = 4 + 0 + \alpha_1 * (4 - 0) + \alpha_2 * (-2)```Simplifying, we get:```i = 4 + 4\alpha_1 - 2\alpha_2```Since \alpha_1 and \alpha_2 are positive constants, we know that i > 4. Therefore, the correct answer is A) 5 percent.

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