We mentioned that the central bank can influence a short-run real interest rate—this is because in the short run the inflation rate is relatively constant but the central bank can adjust the nominal rate on short-term loans.

Recall that after investing in a T-bill, the real rate that investors receive is Real interest rate = Nominal interest rate –

Inflation

a. If inflation is 3% and the Fed wants the real rate on short-term loans to be 2%, what should it set the nominal Fed Funds rate equal to?

b. If inflation is 3%, and the Fed wants to encourage borrowing by cutting the real rate on short-term loans to –1%, what should it set the nominal Fed Funds rate equal to?

c. If inflation is 6%, and the Fed wants to discourage borrowing by raising the real rate on short-term loans to 4%, what should it set the nominal Fed Funds rate equal to?  Lo1