Suppose the the equilibrium real federal funds rate is 4 percent and the target rate of inflation of 1 percent. Use the following information and the Taylor rule to calculate the federal funds rate target.

Current inflation rate = 4 percent

Potential real GDP = $14.72 trillion

Real GDP = $14.81 trillion

The federal funds target rate is ___%

9.81%

Explanation:

Data provided in the question:

Equilibrium real federal funds rate = 4%

The target rate of inflation = 1%

Current inflation rate = 4 percent

Potential real GDP = $14.72 trillion

Real GDP = $14.81 trillion

Now,

Output gap

= [ Real GDP - Potential GDP ] : Potential GDP

= ($14.81 - $14.72) : $14.72

= 0.09 : 14.72

= 0.0061 or 0.61%

Target Federal Funds Rate

= Current Inflation rate + Equilibrium real FFR + 0.5 * (Current inflation rate - Target inflation rate) + 0.5 * Output gap

= 4% + 4% + [ 0.5 * (4% - 1%) ] + [ 0.5 x 0.61% ]

= 8% + [ 0.5 * 3% ] + 0.31%

= 8.31% + 1.5%

= 9.81%