Use the Taylor rule to predict the Fed funds rate in each of

Use the Taylor rule to predict the Fed funds rate in each of the following situations. a. Inflation is 3 percent, the inflation target is 4 percent, and output is 3 percent below potential. Instructions: Enter your response rounded to one decimal place. percent b. Inflation is 4 percent, the inflation target is 3 percent, and output is 3 percent above potential. Instructions: Enter your response rounded to one decimal place. percent c. Inflation is 4 percent, the inflation target is 3 percent, and output is 3 percent below potential. Instructions: Enter your response rounded to one decimal place. percent

Solution

a. Inflation is 3 percent, the inflation target is 4 percent, and output is 3 percent below potential.

nominmal rate = 2% + inflation + 0.5(inlfation - target inflation) + 0.5 log (real output- potential output

r = 2 + 3 + 0.5 (3-4) + 0.5 log x - log3

r = 5-0.5-0.477 = 4.0%

b. Inflation is 4 percent, the inflation target is 3 percent, and output is 3 percent above potential.

r = 2 + 4 + 0.5 (4-3) + log 3

= 6 + 0.5 + 0.477 = 7.0%

c. Inflation is 4 percent, the inflation target is 3 percent, and output is 3 percent below potential.

r = 2 + 4 + 0.5 (4-3) - log 3

= 6 + 0.5 - 0.477 = 6.0%