Answer to Question #136630 in Macroeconomics for Habib

Question

According to the Taylor rule, if inflation is 8 percent and the GDP gap is 3 percent, what is the recommendation for the federal funds rate target?

Answer 1

$Solution$

John Taylor proposed that monetary authorities use a rule for making discretionary decisions.

Taylor's rule states that; the federal funds rate target should be one-and-a- half times the inflation rate plus one-half times the GDP gap plus one.

That is,

$Federal\ fund\ rate=1.5(inflation\ rate)+0.5(GDP\ gap )+1\\ =1.5(8\%)+0.5(3\%)+1\\ =14.5\% (Which\ is\ the\ recommended\ federal\ funds\ rate\ target.)$