According to the taylor rule the fed should raise the

According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation
________ the Fed's inflation target or when real GDP ________ the Fed's output target.
1. A) rises above; drops below
2. B) drops below; drops below
3. C) rises above; rises above
4. D) drops below; rises above
Answer: C
69
Using Taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive output
gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the
nominal federal funds rate target should be

1. A) 5 percent.
2. B) 5.5 percent.
3. C) 6 percent.
4. D) 6.5 percent.
Answer: D
70
Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, there is no output
gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal
funds rate should be
1. A) 0 percent.
2. B) 1 percent.
3. C) 2 percent.
4. D) 3 percent.
Answer: B
71
According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should
be ________ by ________ than the inflation rate increase.
1. A) increased; more
2. B) increased; less
3. C) decreased; more
4. D) decreased; less
Answer: A
72
If the Taylor Principle is not followed and nominal interest rates are increased by less than the
increase in the inflation rate, then real interest rates will ________ and monetary policy will be
too ________.
1. A) rise; tight
2. B) rise; loose
3. C) fall; tight
4. D) fall; loose
Answer: D
73

The rate of inflation tends to remain constant when
1. A) the unemployment rate is above the NAIRU.
2. B) the unemployment rate equals the NAIRU.
3. C) the unemployment rate is below the NAIRU.
4. D) the unemployment rate increases faster than the NAIRU increases.
Answer: B
74
The rate of inflation increases when
1. A) the unemployment rate equals the NAIRU.
2. B) the unemployment rate exceeds the NAIRU.
3. C) the unemployment rate is less than the NAIRU.
4. D) the unemployment rate increases faster than the NAIRU increases.
Answer: C
75
Explain the Taylor rule, including the formula for setting the federal funds rate target, and the
components of the formula. If the Fed were to use this rule, how many goals would it use to set
monetary policy?
Answer: The Taylor rule specifies that the target federal fund rates should be set to equal the
equilibrium real federal funds rate, plus the rate of inflation (for the Fisher effect), plus one-half
times the output gap, plus one-half times the inflation gap. The formula is
Federal funds rate target = equilibrium real federal funds rate + inflation rate + (output gap) +
(inflation gap)
The output gap is the percentage deviation of real GDP from potential full-employment real
GDP. The inflation gap is the difference between actual inflation and the central bank's target rate
of inflation. The equilibrium real federal funds rate is the real rate consistent with full
employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule sets
the federal funds rate recognizing the goals of low inflation and full employment (or equilibrium
long-run economic growth).