The following is a version of the Taylor-rule for the US Fed,

r=0.01+0.5 \frac{(y-y*)}{y*}+0.5\pi

r=0.01+0.5y

(yy)

+0.5

wherer

ris the real Federal Funds rate (policy rate set by the Fed),y

yis output,y*

yis potential output and\pi

is the rate of inflation.

1. According to this Taylor rule, if US GDP is at potential and inflation is 2 percent (0.02 as a decimal), what will be the value of the real Federal Funds rate?
2. In April 2010 the nominal US Federal Funds rate was about 0.20 percent (0.002 in decimals) and annual US inflation was about 2.25 percent (0.0225 in decimals).
3. What was the value of the (ex-post) real Federal Funds rate? Does this make economic sense?
4. Use the above Taylor-rule to calculate the implied size of the output gap for the US.