2. Suppose the current price level in the United Kingdom is 128.40, and one year ago the price level was 126. Output is currently £2900, and potential out put is £3000 (both in billions of 2015 pounds).

a. What value of the key interest rate would the Bank of England (BoE) choose if it followed the Taylor rule given by Eq. (14.6)?

b. Suppose that one year later, the price level has declined by 0.4%, output has declined by 1.3%, and potential output has increased 3%. In this new situation, what value of the key interest rate would the BoE choose if it followed the Taylor rule? What is the problem with setting the key interest rate to follow the Taylor rule in this case?