Suppose that currently the inflation rate is 2 percent and there is no cyclical unemployment. So, the Taylor rule suggests a federal funds rate of 4.00 percent resulting in the real federal funds rate of 2.00 percent. If the inflation rate increases to 10 percent while the cyclical rate of unemployment stays at zero percent, the Taylor rule would recommend a federal funds rate of percent resulting in the real federal funds rate of percent. Now, suppose as before that the inflation rate increases to 10 percent while the cyclical rate of unemployment stays at zero percent. However, the guy at the Fed applies an incorrect formula for the Taylor rule. In particular, he mistakenly believes that the Taylor formula is the following (Full disclosure: He had flunked his money and banking course): FFRTarget = II+FFR -0.50 × (II - II*) +0.50 × (Y) So he recommends a federal funds rate of percent resulting in the real federal funds rate of percent.

Suppose that currently the inflation rate is 2 percent and there is no cyclical unemployment. So, the Taylor rule suggests a federal funds rate of 4.00 percent resulting in the real federal funds rate of 2.00 percent. If the inflation rate increases to 10 percent while the cyclical rate of unemployment stays at zero percent, the Taylor rule would recommend a federal funds rate of percent resulting in the real federal funds rate of percent. Now, suppose as before that the inflation rate increases to 10 percent while the cyclical rate of unemployment stays at zero percent. However, the guy at the Fed applies an incorrect formula for the Taylor rule. In particular, he mistakenly believes that the Taylor formula is the following (Full disclosure: He had flunked his money and banking course): FFRTarget = II+FFR -0.50 × (II - II*) +0.50 × (Y) So he recommends a federal funds rate of percent resulting in the real federal funds rate of percent.

Survey Of Economics

10th Edition

ISBN:9781337111522

Author:Tucker, Irvin B.

Publisher:Tucker, Irvin B.

Chapter13: Inflation

Section: Chapter Questions

Problem 8SQP

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