Question

The Taylor rule specifies how policymakers should set the federal funds rate target. Suppose that U.S. real GDP falls 1% below potential GDP, all else constant. According to the Taylor rule, the Fed should(a) raise or (b) lower

Answer 1

Answer:

The correct answer is option b.

Explanation:

The Taylor rule was given by economist John Taylor. It is a guideline for Federal bank to set interest rate according to changes in output, inflation, etc.  It states that the interest rate should increase with an increase in inflation and unemployment and vice versa.  

Here, the GDP is 1% below the potential GDP so the Fed should lower the interest rate.