The Taylor rule specifies how policymakers should set the federal funds rate target. Suppose that U. S. real GDP rises 1% above potential GDP, all else constant. According to the Taylor rule, the Fed should the federal funds rate target by . Suppose instead that the U. S. inflation rate rises by 1%, all else constant. According to the Taylor rule, the Fed should the federal funds rate target by .

FED raise the federal funds rate target by 0.5%

FED raise the federal fund rate target by 2%

Explanation:

Taylor Rule states that Federal Funds should raise rates when inflation rises. When Gross domestic products growth of a country is high and above potential level then FED should raise rates. When inflation rises by 1% above target level then federal funds should raise FED by 2%.

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