Question

Given the Taylor Rule, if nominal inflation is 4.3%, the FED target inflation rate is 2%, the real Fed Funds rate is 0.7%, the log of real output is 3.0155, and the log of potential output is 3.0445; what should the be the FED’s Fed Funds target rate?

Answer 1

Ans. Taylor rule says that the responsiveness of nominal interest rate set by the central bank to its change in inflation, output and other economic condition. It is done to stabilize price and time inconsistency The Taylor rule can be written in the below equation. I T ar (-T)+ ay (-* I Target Fed Fund rate Tt=Nominal inflation rate = 4.3% T Target inflation rate = 2% Real Fed Fund (interest) rate = 0.7% r Y=Logarithm of real output or GDP = 3.0155 YLogarithm of potential output 3.0445 at, ay are the slope and both are sated as 0.5 by Taylor. From the following question, the value given as above. Now put these values in the above equation and calculate the Target Fed fund Rate

I 4.3+0.7+0.5(4.3-2)+ 0.5(3.0155-3.0445) =5+0.5 2.3+ 0.5 * (-0.029) -5 +1.15 - 0.0145 -6.15-0.0145 -6.1355 Thus the FED's Fund target rate is 6.1355