**Calculating the Current Federal Fund Rate Using the Taylor Rule**The Taylor Rule is a monetary policy guideline used to determine the appropriate federal funds rate based on economic conditions. The formula is given by:\[ \text{Federal Fund Rate} = \text{Equilibrium Real Interest Rate} + \text{Current Inflation Rate} + 0.5 (\text{Inflation Gap}) + 0.5 (\text{Output Gap}) \]**Given Variables:**- Current Inflation Rate: 5%- Target Inflation Rate: 3%- Equilibrium Real Interest Rate: 0.7%- Potential GDP: $14,000- Actual GDP: $15,000**Step-by-Step Calculation:**1. **Calculate the Inflation Gap:** \[ \text{Inflation Gap} = \text{Current Inflation Rate} - \text{Target Inflation Rate} \] \[ \text{Inflation Gap} = 5\% - 3\% = 2\% \]2. **Calculate the Output Gap:** \[ \text{Output Gap} = \left( \frac{\text{Actual GDP} - \text{Potential GDP}}{\text{Potential GDP}} \right) \times 100 \] \[ \text{Output Gap} = \left( \frac{15,000 - 14,000}{14,000} \right) \times 100 \] \[ \text{Output Gap} = \left( \frac{1,000}{14,000} \right) \times 100 \] \[ \text{Output Gap} \approx 7.14\% \]3. **Apply the Taylor Rule Formula:** \[ \text{Federal Fund Rate} = 0.7\% + 5\% + 0.5 \times 2\% + 0.5 \times 7.14\% \] \[ \text{Federal Fund Rate} = 0.7\% + 5\% + 1\% + 3.57\% \] \[ \text{Federal Fund Rate} = 10.27\% \]Thus, the current federal fund rate using the Taylor Rule is **10.27%**.

Answered: What is the current federal fund rate…

What is the current federal fund rate using Taylor Rule. The inflation rate is 5%, target inflation rate is 3%, and equilibrium real nterest rate 0.7%, potential GDP $14,000 and actual GDP $15,000.?

ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

**Calculating the Current Federal Fund Rate Using the Taylor Rule**

The Taylor Rule is a monetary policy guideline used to determine the appropriate federal funds rate based on economic conditions. The formula is given by:

\[ \text{Federal Fund Rate} = \text{Equilibrium Real Interest Rate} + \text{Current Inflation Rate} + 0.5 (\text{Inflation Gap}) + 0.5 (\text{Output Gap}) \]

**Given Variables:**
- Current Inflation Rate: 5%
- Target Inflation Rate: 3%
- Equilibrium Real Interest Rate: 0.7%
- Potential GDP: $14,000
- Actual GDP: $15,000

**Step-by-Step Calculation:**

1. **Calculate the Inflation Gap:**
\[ \text{Inflation Gap} = \text{Current Inflation Rate} - \text{Target Inflation Rate} \]
\[ \text{Inflation Gap} = 5\% - 3\% = 2\% \]

2. **Calculate the Output Gap:**
\[ \text{Output Gap} = \left( \frac{\text{Actual GDP} - \text{Potential GDP}}{\text{Potential GDP}} \right) \times 100 \]
\[ \text{Output Gap} = \left( \frac{15,000 - 14,000}{14,000} \right) \times 100 \]
\[ \text{Output Gap} = \left( \frac{1,000}{14,000} \right) \times 100 \]
\[ \text{Output Gap} \approx 7.14\% \]

3. **Apply the Taylor Rule Formula:**
\[ \text{Federal Fund Rate} = 0.7\% + 5\% + 0.5 \times 2\% + 0.5 \times 7.14\% \]
\[ \text{Federal Fund Rate} = 0.7\% + 5\% + 1\% + 3.57\% \]
\[ \text{Federal Fund Rate} = 10.27\% \]

Thus, the current federal fund rate using the Taylor Rule is **10.27%**.

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