Since monetary policy changes through the fed funds rate occur with a lag, policymakers are usually more concerned with adjusting policy according to changes in the forecasted or expected inflation rate, rather than the current inflation rate. In light of this, suppose that monetary policymakers employ the Taylor rule to set the fed funds rate, where the inflation gap is defined as the difference between expected inflation and the target inflation rate. Assume that the weights on both the inflation and output gaps are 1/2, the equilibrium real fed funds rate is 3%, the inflation rate target is 1%, and the output gap is 3%.

If the expected inflation rate is 5%, according to the Taylor rule, the fed funds rate should be set at (Round your response to one decimal place.)

Suppose half of Fed economists forecast inflation to be 4%, and half of Fed economists forecast inflation to be 6%.

If the Fed uses the average of these two forecasts as its measure of expected inflation, according to the Taylor rule, the fed funds rate should be set at

enter your response here%. (Round your response to one decimal place.)

Now suppose half of Fed economists forecast inflation to be 0%, and half forecast inflation to be 10%.

If the Fed uses the average of these two forecasts as its measure of expected inflation, according to the Taylor rule, the fed funds rate should be set at (Round your response to one decimal place.)

Given your answers to the previous steps, do you think it is a good idea for monetary policymakers to use a strict interpretation of the Taylor rule as a basis for setting policy?

A.

Definitely not. The empirical data show the Taylor rule is inefficient in monetary policymaking.

B.

Probably not. The Taylor rule doesn't take into account the possibility of a wide variation in forecasts.

C.

Definitely yes. A strict interpretation of the Taylor rule helps the Fed to pursue highly accurate monetary policy.

D.

Probably yes. Despite the regular inaccuracy, the Taylor rule is still the best rule for forecasting.