Question
just question b and c
t the inflation target does not change)? e down the equation for the Taylor rule for monetary policy. Explain what each term uation means, in one sentence. ose the Fed is following the Taylor rule. b Supp ose the growth rate of potential output is 3 percent, the output gap is -6 the weights on the output gap and inflation gap are 2 percent, the Fed believes the equilibrium real federal funds rate is 3 percent, and the inflation rate has been 2 percent over the past year. At what level does the Fed set the federal funds rate? percent, each 2, the Fed's inflation target is c Suppose the Fed thinks that the equilibrium federal funds rate is 3 percent, as in part b above, but in fact the equilibrium real fed funds rate is 4 percent. What do you think will happen to the inflation rate in the long run?
Explanation / Answer
i = r* + pi + 0.5 (pi-pi*) + 0.5 (y-y*)
Where:
i = nominal fed funds rate
r* = real federal funds rate I =
pi = rate of inflation
p* = target inflation rate
Y = logarithm of real output
y* = logarithm of potential output
B)
I = .03+.02+0.5*(0.02-0.02)+0.5(0.06-0.03)
i = 0.065 = 6.5 %
C)
Pi = i-r*-0.5*(Pi-P*)-0.5*(y-y*)
Pi = 0.065-0.04-0.5*0+0.5*(0.03) = 0.04 = 4%