Use the following Taylor rule to calculate what would happen to the real interes

Question

Use the following Taylor rule to calculate what would happen to the real interest rate if inflation increased by 5 percentage points.

       Target federal funds rate = 2 + Current inflation + 1/2 (Inflation gap) + 1/2(Output gap)

Instructions: Round your answers to one decimal place.

If inflation goes up by 5 percentage points, the target federal funds rate goes up by ______ percentage points (______ percentage points due to the direct impact of inflation and another______ percentage points due to an increase in the inflation gap).

According to the Fisher equation, if the nominal rate increased by______ percentage points and inflation increased by_______ percentage points, the real interest rate must have increased by_______ percentage points.

Explanation / Answer

5%

2.5%

10%

5%

5%

Nominal = Real + Inflation -> Fischer Equation

=> Nominal = 10%

Real = 5%

Inflation = 5%

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