Question

Suppose that in 1980, the U.S. inflation rate was 12.5 percent and the unemployment rate reached 7.4 percent, Suppose that the target rate of inflation was 2.5 percent back then and the full-employment rate of unemployment was 5 percent at that time. What value does the Taylor Rule predict for the Fed's target interest rate? Instructions: Enter your answer rounded to 2 decimal places. percent

Answer 1

The Taylor Rule predicts that the Fed's target interest rate would be 18.7% based on the given inflation rate of 12.5% and unemployment rate of 7.4% in 1980.

Step-by-step explanation:

The Taylor Rule is a monetary policy guideline that suggests what the central bank's target interest rate should be based on the prevailing economic conditions. The formula used to calculate the target interest rate is:

Target Interest Rate = Neutral Interest Rate + (1.5 * Inflation Gap) + (0.5 * Output Gap)

In this case, the neutral interest rate is 2.5% (the target rate of inflation), the inflation gap is 12.5% - 2.5% = 10%, and the output gap is 7.4% - 5% = 2.4%. Using these values, we can calculate the target interest rate:

Target Interest Rate = 2.5% + (1.5 * 10%) + (0.5 * 2.4%)

= 2.5% + 15% + 1.2%

= 18.7%

Answer 2

The Taylor Rule predicts the target interest rate for central banks based on inflation and unemployment rates. The formula for the Taylor Rule is target interest rate = equilibrium interest rate + 0.5 * (actual inflation rate - target inflation rate) + 0.5 * (actual unemployment rate - full-employment unemployment rate). Plugging in the given values, the Taylor Rule predicts that the Fed's target interest rate in 1980 would be the equilibrium interest rate plus 6.2%.

Step-by-step explanation:

The Taylor Rule is a monetary policy guideline that provides a suggested target interest rate for central banks based on inflation and unemployment rates. It is named after economist John Taylor.

The formula for the Taylor Rule is: target interest rate = equilibrium interest rate + 0.5 * (actual inflation rate - target inflation rate) + 0.5 * (actual unemployment rate - full-employment unemployment rate)

Using the given information, the target inflation rate is 2.5% and the full-employment unemployment rate is 5%. The actual inflation rate in 1980 was 12.5% and the actual unemployment rate was 7.4%.

Plugging these values into the Taylor Rule formula, we get: target interest rate = equilibrium interest rate + 0.5 * (12.5% - 2.5%) + 0.5 * (7.4% - 5%) = equilibrium interest rate + 5% + 1.2%

Therefore, the Taylor Rule predicts that the Fed's target interest rate in 1980 would be the equilibrium interest rate plus 6.2%.