Question $6(10$ points$)$

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Scenario: Taylor Rule

Suppose that the Federal Reserve is following the Taylor rule, which takes both inflation and business cycles into account in setting the federal funds rate. Also suppose that the inflation rate is $5\%$ and that the unemployment gap is $2\%.$ The economy has a$($n$)$:

inflationary gap, since the inflation rate is high.

recessionary gap, since the economy is not producing at potential output.

inflationary gap, since actual real GDP exceeds potential real GDP$.$

recessionary gap, since potential real GDP exceeds actual real GDP$.$