Suppose that the economy is thought to be 2% above potential ( that is, output g

Question

Suppose that the economy is thought to be 2% above potential ( that is, output gap is 2%) when potential output grows 4% per year. Suppose also that the Fed is following the Taylor rule, with an inflation rate of 2% over the past year. The federal funds rate is currently 3%. the equilibrium real federal funds rate is 3%, and the weights on the output gap and inflation gap are 0.5 each.

The inflation target is 1%.
A: Is the Federal funds rate currently too high or too low? by how much? and how did you come up wth this

Hint to solving problem 11:

a. Use the equation that i = r + ?e; combine that with the equation that r = 8.5 ? %?Y and that people will expect the Fed to hit its inflation target, so ?e = ?T = 2 percent, and that output growth is expected to equal the rate of potential output growth, %?Y = %?Y* = 3.5%, to get

First Step: %?V = 0.5

Explanation / Answer

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