Question

Given the following Taylor rule:

Target federal funds rate = natural rate of interest + current inflation + 1/2(inflation gap) +1/2(output gap);

Explain what happens to the real interest rate and why it happens, each time inflation increases

by 1 percent.

Answer #1

Given the following Taylor rule:

Target federal funds rate = natural rate of interest + current inflation + 1/2(inflation gap) +1/2(output gap);

Taylor rule suggests that the difference between the nominal interest rate and nominal interest rate is inflation. The real interest rate accounts for inflation but the nominal interest rate does not account for it. So when inflation increases the real interest rate decrease. In other words when inflation increases by 1 per cent the real interest rate decrease by 1 per cent. When the inflation is high the real GDP will fall even if it can go to negative in the real term which signals economic contraction. In other words, it tells that when the economy in contraction there is slow economic growth. The slow economic growth causes a decline in real interest rates.

Use the following Taylor rule to calculate what would happen to
the real interest rate if inflation increased by 5 percentage
points. Target federal funds rate = Natural rate of interest +
Current inflation + 1/2(Inflation gap) + 1/2(Output gap)
If inflation goes up by 5 percentage points, the target
(nominal) federal funds rate goes up by ?
percentage points (? percentage points due to the
direct impact of inflation and another ?
percentage points due to an increase in...

Use the following Taylor rule to calculate what would happen to
the real interest rate if inflation increased by 1 percentage
points. Target federal funds rate = Natural rate of interest +
Current inflation + 1/2(Inflation gap) + 1/2(Output gap)
Instructions: Enter your responses rounded to one decimal
place.
If inflation goes up by 1 percentage points, the target
(nominal) federal funds rate goes up by ? percentage points ( ?
percentage points due to the direct impact of inflation...

Use the following Taylor rule to calculate what would happen to
the real interest rate if inflation increased by 1 percentage
points.
Target federal funds rate = 2 + Current inflation + 1/2
(Inflation gap) + 1/2(Output gap)
If inflation goes up by 1 percentage points, the target federal
funds rate goes up by ___ percentage points ( ___ percentage points
due to the direct impact of inflation and another __ percentage
points due to an increase in the inflation...

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.

Suppose that the natural rate of interest is 2 percent and the
current rate of inflation is 4 percent. If the inflation gap is 2
percent and the rate of real GDP growth is 3 percent above its
potential, the FOMC’s target fed-funds rate is:

Use the Fed rule-of-thumb to predict how the
Fed would want to change the federal funds rate and the real
interest rate targets for each of the following scenarios if its
estimate of the neutral real interest rate is 2%.
a. A recession hits the economy leading output to be 0.75% below
potential output and inflation to fall to 1%.
b. An increase in consumer and business confidence pushes the
economy to produce output at 2% above potential output while...

Use the Taylor rule to predict the Fed funds rate in each of the
following situations. a. Inflation is 3 percent, the inflation
target is 4 percent, and output is 3 percent below potential.
Instructions: Enter your response rounded to one decimal place.
percent b. Inflation is 4 percent, the inflation target is 3
percent, and output is 3 percent above potential. Instructions:
Enter your response rounded to one decimal place. percent c.
Inflation is 4 percent, the inflation target...

Recall the Taylor Rule for interest rate targeting. ? = ? ∗ + ?
+ ?(? − ? ∗ ) + ?? ? Consider an economy where the equilibrium real
interest rate is ? ∗ = 0.02 and the central bank’s target inflation
rate is ? ∗ = 0.02. The central bank equally weights inflation and
output deviations, i.e. ? = ? = 0.5
a. Suppose that inflation is currently 1.3%. Also, while the
economy’s potential GDP is $12 trillion,...

Please Answer in detail.
Go to the St. Louis Federal Reserve FRED database, and find data
on the personal consumption expenditure price index
(PCECTPI), real GDP (GDPC1), an
estimate of potential GDP (GDPPOT), and the
federal funds rate (DFF).
For the price index, adjust the units setting to “Percent Change
From Year Ago” to convert the data to the inflation rate;
For the federal funds rate, change the frequency setting to
“Quarterly.”
Download the data into a spreadsheet.
Assuming the...

Suppose the Fed commits itself to the use of the Taylor rule?
(shown below) to set the federal funds rate. Federal funds rate
equals Long minus run target plus 1.5 left parenthesis Inflation
rate minus Inflation target right parenthesis plus 0.5 left
parenthesis Output gap right parenthesis Suppose the Fed has set
the? long-run target for the federal funds rate at 2.5 percent and
its target for inflation at 3 percent. If the economy is currently
hitting the? Fed's inflation...

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