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      Question

      The Taylor Rule is a guideline for central banks setting

      the nominal federal funds rate (iT). If the rule is given by iT=rβˆ—+Ο€+0.5(Ο€βˆ’Ο€βˆ—)+0.5(Yβˆ’Yβˆ—), where rβˆ—=2%, Ο€βˆ—=2%, and Y is the output gap (as a percentage), what is the target nominal rate if inflation (Ο€) is 4% and the output gap (Yβˆ’Yβˆ—) is 2%?
      A 6% Correct Answer Incorrect Answer
      B 8% Correct Answer Incorrect Answer
      C 9% Correct Answer Incorrect Answer
      D 10% Correct Answer Incorrect Answer

      Solution

      Solution: The Taylor Rule formula is: iT=rβˆ—+Ο€+0.5(Ο€βˆ’Ο€βˆ—)+0.5(Yβˆ’Yβˆ—) Given values: rβˆ— (Real equilibrium rate) =2% Ο€βˆ— (Target inflation rate) =2% Ο€ (Actual inflation rate) =4% (Yβˆ’Yβˆ—) (Output gap) =2% Substitute the values into the rule: iT=2+4+0.5(4βˆ’2)+0.5(2)iT=6+0.5(2)+0.5(2)iT=6+1+1 iT=8%

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