Suppose the Economy Is Thought to Be 1 Percent Below

Multiple Choice

Suppose the economy is thought to be 1 percent below potential (i.e., the output gap is −1 percent) , when potential output grows 4 percent per year.Suppose the Fed is following the Taylor rule, with an inflation rate of 4 percent over the past year.The equilibrium real federal funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each.The inflation target is 1 percent.What should the federal funds rate be?

A) 4 percent
B) 6 percent
C) 8 percent
D) 12 percent