1. [3 pts.]Under the Taylor rule in equation

i =P + 0.02 + 0.5y + 0.5 (P - 0.02),

nominal FED funds rate is set based on real interest rates (assume r = 0.02 or 2% in the U.S in the long-run), inflation (P), and output and inflation gaps, represented by y and (P - 0.02),respectively. Use weights of 0.5 and 0.5 to both output and inflation gaps. Calculate i, the nominal FED funds rate the central bank sets, when:

There is nooutput gap (y). Current inflation rate (P) is at 6.2% based on yearly CPI growth rate, which is higher than the 2% target (1 pt.)

Inflation rate remains at 6.2%, r at 2%, but now output gap is equal to -0.02 (output gap y is now 2% in the negative direction) and there is inflation gap as before. Comment on the nominal interest rate the Fed should set using the Taylor rule compared to what you obtained in 2a (1 pt.)

What is your general conclusion, if Taylor rule were followed, from a and b given that the current nominal interest rate in the U.S. is now close to 0%? Comment. (1 pt.)