Use the following Taylor rule to calculate what would happen to the real interest rate if inflation increased by 2 percentage points. Target federal funds rate = Natural rate of interest + Current inflation + 1/2(Inflation gap) + 1/2(Output gap)

Instructions: Enter your responses rounded to one decimal place.

If inflation goes up by 2 percentage points, the target (nominal) federal funds rate goes up by _____ percentage points (_____ percentage points due to the direct impact of inflation and another ______ percentage points due to an increase in the inflation gap). Consider the Fisher equation. Given the increase in the nominal interest rate you just calculated and the 2 percentage point increase in inflation we started with, the real interest rate must have increased by _____ percentage points.