Question 4 2 pts According to the Taylor rule how should the

Question 4 2 pts According to the Taylor rule, how should the nominal federal funds rate respond to an increase in the Fed\'s inflation target? OIt should increase. It should decrease It should not change. The Fed\'s inflation target does not appear in the Taylor rule.

Solution

The Taylor rule is used to set targets for the Federal fund rates in response to deviations of real output and inflation from their targets.

Given an increase in Fed\'s inflation targets, the nominal Federal fund rates should decrease.

This is because inflation gap i.e. actual inflation - target inflation is a positive component of the federal fund rate formula. As the Fed increases the inflation target, the inflation gap decreases and thus the Federal fund rate should also decrease.

Ans. (b)