Question

Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, the positive output gap is 2 percent, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal funds rate should be:

A) 0 percent.

B) 1 percent.

C) 2 percent.

D) 3 percent.

Answer 1

The correct answer is (C) 2 Percent

According to Taylor rule :

i = r* + e + 0.5 (e - e*) + 0.5 (y-y*)

where i = Here y - y* = output gap = 2% , r* = real federal fund rate = 2% , e = actual inflation rate = 0% and e* = target inflation rate = 2% and i = nominal federal fund rate

=> i = 2% + 0% + 0.5 (0 - 2) + 0.5 (2%)

=> i = 2% + 0% + 0.5*(-2%) + 0.5*2% = 2%

=> i = 2%

Hence Nominal Federal Fund rate = 2%.

Hence, the correct answer is (C) 2 Percent