Question

g If the Fed were to set policy according to the Taylor rule, then if real GDP falls by 2 percent below potential GDP, the Fed should Multiple Choice raise the real federal funds rate by 1 percentage point. reduce the real federal funds rate by 1 percentage point. raise the inflation rate by 1 percentage point. change the real federal funds rate until inflation hits the target rate of 4 percent.

Answer 1

Answer: reduce the real federal funds rate by 1 percentage point

Step-by-step explanation:

According to the Taylor Rule, the Fed should use monetary policy to stimulate the economy when it dips below the potential GDP.

One way it can do this is to reduce interest rates. This will make the cost of borrowing less and convince both people and businesses to borrow money. They can then spend and invest this money which would contribute to both consumption and investment spending thereby ultimately increasing GDP.

They can reduce interest rates by reducing the federal funds rate.