Author Question: An appropriate fiscal policy response when aggregate demand is growing at a slower rate than ... (Read 289 times)

Mollykgkg · **on:** Jun 29, 2018

An appropriate fiscal policy response when aggregate demand is growing at a slower rate than aggregate supply is to cut taxes.

Indicate whether the statement is true or false

Question 2

Consider the Taylor rule for the target of the federal funds rate.

Suppose the equilibrium real federal funds rate is 2 percent, the target rate of inflation is 3 percent, the current inflation rate is 3 percent, real GDP equals potential real GDP, and the weights are 1/2 for the inflation gap and the output gap. Using the Taylor rule, what does the target for the federal funds rate equal? Next, if the Federal Reserve lowered the target for the inflation rate to 1 percent, how much would the target for the federal funds rate change?

todom5090 · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

TRUE

Answer to Question 2

The federal funds target rate would equal 5 percent. With no inflation gap or output gap, the federal funds target rate equals the current inflation rate plus the equilibrium real federal funds rate. A decrease in the inflation target from 3 percent to 1 percent with a weight on the inflation gap of 1/2 would raise the federal funds target rate by 1 percentage point, from 5 percent to 6 percent.