Is the feds funds rate currently too high or too low

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Reference no: EM131098387

Suppose the economy is thought to be 1 percent above potential (i.e., the output gap is 1 percent), when potential output grows 3 percent per year. Suppose the Fed is following the Taylor rule, with an inflation rate of 3 percent over the past year. The federal funds rate is currently 4 percent. The equilibrium long-run real interest rate is 2 percent and the weights on the the output gap and inflation gap are 0.5 each. The inflation target is 2 percent. a) Is the feds funds rate currently too high or too low? By how much? Show your work. b) Suppose a year has gone by, output is now just 2 percent above potential, and inflation rate was 3.5 percent over the year. What federal funds rate should the Fed now set (assuming the inflation target does not change)?

Reference no: EM131098387

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