The Taylor rule can be written as FF rate = $\pi$ + 2.0 + 0.5 ( $\pi$- 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate, $\pi$ is the inflation rate, and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 2 percent and the GDP gap is -2 percent, then according to the Taylor rule, the Fed should set the nominal federal funds rate at _____ percent.
A) 2
B) 3
C) 4
D) 5

Question

The Taylor rule can be written as FF rate =  $\pi$ + 2.0 + 0.5 ( $\pi$- 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate,  $\pi$ is the inflation rate, and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 2 percent and the GDP gap is -2 percent, then according to the Taylor rule, the Fed should set the nominal federal funds rate at _____ percent.
A) 2
B) 3
C) 4
D) 5

Quizplus · Accepted Answer

The Taylor rule formula becomes: FF rate = 2 + 0.5(2 - 2) + 0.5(-2) = 2 + 0 - 1 = 1%. However, the base rate is 2%, so the final rate is 3%.

The Taylor Rule Can Be Written as FF Rate = π\piπ

The Taylor Rule Can Be Written as FF Rate = $\pi$