Question
The Taylor Rule is a guideline for central banks setting
the nominal federal funds rate (iT). If the rule is given by iT=r∗+π+0.5(π−π∗)+0.5(Y−Y∗), where r∗=2%, π∗=2%, and Y is the output gap (as a percentage), what is the target nominal rate if inflation (π) is 4% and the output gap (Y−Y∗) is 2%?Solution
Solution: The Taylor Rule formula is: iT=r∗+π+0.5(π−π∗)+0.5(Y−Y∗) Given values: r∗ (Real equilibrium rate) =2% π∗ (Target inflation rate) =2% π (Actual inflation rate) =4% (Y−Y∗) (Output gap) =2% Substitute the values into the rule: iT=2+4+0.5(4−2)+0.5(2)iT=6+0.5(2)+0.5(2)iT=6+1+1 iT=8%
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