Using taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the nominal federal funds rate target should be a. 5 percent. b. 5.5 percent. c. 6 percent. d. 6.5 percent.

The correct answer is option D.

Explanation:

Taylor's rule was given by the economist John Taylor. Taylor gave this rule to forecast interest rate. According to him, the Fed should increase the interest rates when the inflation rate is above target or when GDP is above potential level and vice versa.  

Nominal federal funds rate

= Real federal funds rate + actual inflation rate + 0.5 × deviation of output from target + 0.5 × (Real inflation rate - Target inflation rate)

= 3 + 2 + (0.5 × 2) + 0.5 × (2 - 1)

= 3 + 2 + 1 + 0.5

= 6.5  

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