
- Fed target funds rate according to Taylor rule when inflation rate is 4%
- According to Taylor rule when inflation rate is 3% and 5%, Fed target funds rate on average of these two
forecasts
- According to Taylor rule when inflation rate is 0% and 8%, Fed target funds rate on average of these two forecasts
- Suitability of Taylor’s Rule

Explanation of Solution
According to Taylor rule the federal funds rate target = 7.5%
According to Taylor rule the federal funds rate target is calculated using the following formula −
Given that:
Inflation rate = 4%
Equilibrium Real Fed Funds Rate = 2%
Output Gap = 1%
Requirement 2:
According to Taylor rule when inflation rate is 3% and 5%, Fed target funds rate on average of these two forecasts
Answer:
According to Taylor rule the federal funds rate target = 7.5%
Given that:
Inflation rate = 3%
Equilibrium Real Fed Funds Rate = 2%
Output Gap = 1%
Given that:
Inflation rate = 5%
Equilibrium Real Fed Funds Rate = 2%
Output Gap = 1%
Average of these two forecasts will be
Requirement 3:
According to Taylor rule when inflation rate is 0% and 8%, Fed target funds rate on average of these two forecasts
Answer:
According to Taylor rule the federal funds rate target = 7.5%
Given that:
Inflation rate = 0%
Equilibrium Real Fed Funds Rate = 2%
Output Gap = 1%
Given that:
Inflation rate = 8%
Equilibrium Real Fed Funds Rate = 2%
Output Gap = 1%
Average of these two forecasts will be
Requirement 4:
Suitability of Taylor’s Rule
Answer:
It is necessary to interpret Taylor’s rule strictly because even at varied inflation rates it gives the same target rate.
Introduction:
Taylor’s rule is a proposed guideline which describes the interest rate decisions of central banks. It is based on the following three factors:
- 1) Targeted versus actual inflation levels;
2) Full employment versus actual employment levels;
3) The short-term interest rate appropriately consistent with full employment
Requirement 1:
Fed target funds rate according to Taylor rule when inflation rate is 4%
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Chapter 19 Solutions
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