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Using the Taylor rule, if inflation is 1 percent, desired inflation is 2 percent, and output is 2 percentage points below potential

Using the Taylor rule, if inflation is 1 percent, desired inflation is 2 percent, and output is 2 percentage points below potential, the Fed should target a federal funds rate of 

 Α. 6.5.

 B. 4.5.

 C. 2.5.

 D. 1.5.


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Answer #1

Using the Taylor rule, the should target a federal funds rate equal to 2 + actual inflation + 0.5(actual inflation less desired inflation) + 0.5(percent deviation of aggregate output from potential)

= 2 + 1 + (0.5)(1-2) + (0.5)(-2)

= 2 +1 -0.5 - 1

= 1.5

The fed should target a federal funds rate of 1.5. Hence, option(D) is correct.

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