If the Fed's policy reaction function equals r = .02 + π, where r is the real interest rate and π is the inflation rate. If the real rate of interest is set at 5 percent, then the rate of inflation must be:
A)2 percent.
B)3 percent.
C)1 percent.
D)4 percent.

Question

Quizplus · Accepted Answer

According to the reaction rule, the Federal Reserve will set the real interest rate to whatever the rate of inflation is plus 2 percent. So if the rate of real interest is 5 percent, the rate of inflation must be 3 percent (5 - 2).

If the Fed's Policy Reaction Function Equals R =