In: Finance
According to the Taylor Rule, if the output gap falls by 2% and the inflation gap rises by 1%, then the real federal funds rate should be
Select one:
A. lowered by 1.0%.
B. lowered by 0.5%.
C. left unchanged.
D. raised by 1.0%.
According to the Taylor Rule, if the output gap falls by 2% and the inflation gap rises by 1%, then the real federal funds rate should be
correct answer is : B : lowered by 0.5%
The formula is
Federal funds rate target = equilibrium real federal funds rate +
inflation rate + 1/2(output gap) + 1/2(inflation gap)
in our case : 1/2(-2) + 1/2(1) = -0.5%
The Taylor rule :
The rules states that the target federal fund rates should be set to equal the equilibrium real federal funds rate, plus the rate of inflation, plus one-half times the output gap, plus one-half times the inflation gap.
The formula is
Federal funds rate target = equilibrium real federal funds rate +
inflation rate + 1/2(output gap) + 1/2(inflation gap)
The output gap is the percentage change or deviation of real GDP
from potential full-employment real GDP.
where as the inflation gap is the difference between actual inflation and the central bank's target rate of inflation.
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