Question

Assume that you are the central banker and you are faced with the following economic conditions. Assume that the natural rate of unemployment is 5%, and that the target inflation rate is 2%.

a. i_1t = 8%, ? = 3%, ? = 10%. What monetary policy would you implement? Initially assume that the expected future short-term interest rates are currently 8%, and that the goal of your policy, is to change all expected future short-term interest rates by the same amount. Start off by explaining if you would buy or sell one year treasury bills. Draw a graph and show how this would affect the yield curve.

b. i_1t= 0%, ? = 10%, ? = 0.5% Determine what monetary policy you would implement. Draw a graph and show how this would affect the yield curve. Initially assume that the expected future short-term interest rates are currently 0%, before you take any action.

Answer 1