Use the Taylor rule: ????= ???? + ????? ? 1 ? (???? ? 0.04) + 0.5 (???? ? 0.02). The long-run average value of the real interest rate = 0.03, the target rate of inflation = 0.02, the natural unemployment level is 0.04. when unemployment is at its natural level and inflation is on target, the nominal interest rate = 0.05.
Suppose that unemployment is 0.04 and inflation grows from 0.02 to 0.04%
* What will the Fed set the nominal interest rate to if it follows the Taylor rule? Does Fed buy or sell bonds to bring about the change in the nominal interest rate?
* What will the real interest be after the Fed acts? Up or down? relate the answer about the change in the real interest rate to the Taylor rule.