1. Suppose the economy is thought to be 1 percent below potential (i.e., the output gap is −1 percent), when potential output grows 4 percent per year. Suppose the Fed is following the Taylor rule, with an inflation rate of 4 percent over the past year. The equilibrium real federal funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each. The inflation target is 1 percent. What should the federal funds rate be?
A) 4 percent
B) 6 percent
C) 8 percent
D) 12 percent
2. If the potential output of an economy is worth $440 billion and the actual output during a particular year was $435 billion, the output gap is?
A) -1.14 percent
B) 2.2 percent
C) -5 percent
D) 1.1 percent