Question

Suppose the the equilibrium real federal funds rate is 4 percent and the target rate of inflation of 1 percent. Use the following information and the Taylor rule to calculate the federal funds rate target.

Current inflation rate = 4 percent
Potential real GDP = $14.72 trillion
Real GDP = $14.81 trillion

The federal funds target rate is ___%

Answer 1

Using the Taylor rule and given information, the federal funds target rate is calculated to be 8.31%.

Step-by-step explanation:

To determine the federal funds rate target, we can apply the Taylor rule formula:

Federal funds target rate = Equilibrium real federal funds rate + Current inflation + 0.5(Output Gap) + 0.5(Inflation Gap)

where:

• Equilibrium real federal funds rate represents the long-term rate that would prevail when the economy is operating at full capacity and inflation is stable. In this case, it is 4%.
• Current inflation is the rate at which prices of goods and services are rising. Here, it is 4%.
• Output Gap is the percentage difference between actual real GDP and potential real GDP. Thus, Output Gap = ((Real GDP - Potential real GDP) / Potential real GDP) * 100 = ((14.81 trillion - 14.72 trillion) / 14.72 trillion) * 100 = 0.61%.
• Inflation Gap is the difference between the current inflation rate and the target inflation rate. Here, it is 4% - 1% = 3%.

Substitute the given values into the Taylor rule formula:

Federal funds target rate = 4% + 4% + 0.5(0.61) + 0.5(3%) = 8.305% which can be rounded to 8.31%.

Therefore, the federal funds target rate is 8.31% percent.

Answer 2

9.81%

Step-by-step explanation:

Data provided in the question:

Equilibrium real federal funds rate = 4%

The target rate of inflation = 1%

Current inflation rate = 4 percent

Potential real GDP = $14.72 trillion

Real GDP = $14.81 trillion

Now,

Output gap

= [ Real GDP - Potential GDP ] ÷ Potential GDP

= ( $14.81 - $14.72 ) ÷ $14.72

= 0.09 ÷ 14.72

= 0.0061 or 0.61%

Target Federal Funds Rate

= Current Inflation rate + Equilibrium real FFR + 0.5 × (Current inflation rate - Target inflation rate) + 0.5 × Output gap

= 4% + 4% + [ 0.5 × (4% - 1%) ] + [ 0.5 x 0.61% ]

= 8% + [ 0.5 × 3% ] + 0.31%

= 8.31% + 1.5%

= 9.81%