Question

Suppose a central bank decides to conduct monetary policy according to a rule for interest rates....

Suppose a central bank decides to conduct monetary policy according to a rule for interest rates.

a) How does it choose the basic setting for the interest rate within the rule?

b) How would it respond to a rise in the output gap (Y −YP)?

c) How would the bank react to an inflation rate higher than its target inflation rate?


Homework Answers

Answer #1

a) The Central bank could choose Taylor's Rule setting the interest rate.

Taylor's Rule says that:

i​​​​= r*+ p+0.5(p–p*)+0.5(Y–Yp)

Where i= Nominal Interest Rate

r*= Real Interest Rate

p= Rate of Inflation

p*= Target Inflation Rate

Y= Output

Yp= Potential Output

b) It would Increase the Nominal Interest Rate as Output Gap Increases as can be seen from the equation above.

c) If Inflation Rate is Higher than its target Inflation Rate then it will increase the Nominal Interest Rate. This again could ne seen from the equation above. In the equation, as p Increases and is Higher than p*, Central bank would Increase the nominal Interest Rate

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Recall the Taylor Rule for interest rate targeting. ? = ? ∗ + ? + ?(?...
Recall the Taylor Rule for interest rate targeting. ? = ? ∗ + ? + ?(? − ? ∗ ) + ?? ? Consider an economy where the equilibrium real interest rate is ? ∗ = 0.02 and the central bank’s target inflation rate is ? ∗ = 0.02. The central bank equally weights inflation and output deviations, i.e. ? = ? = 0.5 a. Suppose that inflation is currently 1.3%. Also, while the economy’s potential GDP is $12 trillion,...
Assume the central bank decides to move and close the GDP gap instead of fiscal policy....
Assume the central bank decides to move and close the GDP gap instead of fiscal policy. In what direction will interest rates have to move to close the GDP gap and what type of open market operation will the central bank undertake? GDP gap (Recessionary and inflationery)
1-Explain how the central bank conduct monetary policy by targeting the federal fund rate, and through...
1-Explain how the central bank conduct monetary policy by targeting the federal fund rate, and through open market operation. 2- Explain the non-conventional monetary policy: the quantifying easining. 3-Briefly talk about the differences between monetarist monetary policy and Keynesian monetary policy. answer this question hurry up plz
Interest rates fall when the central bank conducts contractionary monetary policy an increase in savings increases...
Interest rates fall when the central bank conducts contractionary monetary policy an increase in savings increases the supply of loanable funds in the economy a new technology leads people to borrow more in order to invest in the new technology the central bank sells Treasury bills
PROBLEM 5:   MONETARY POLICY If the central bank of Canada institutes a contractionary monetary policy, describe...
PROBLEM 5:   MONETARY POLICY If the central bank of Canada institutes a contractionary monetary policy, describe what will happen to the following variables relative to what would happen without the policy: The money supply Interest rates Investment Consumption Net Exports The aggregate demand curve Real GDP The price level The value of the Canadian dollar The long run aggregate supply curve PROBLEM 5:   MONETARY POLICY If the central bank of Canada institutes a contractionary monetary policy, describe what will happen...
Using the concepts of fiscal/monetary policies, active/passive policies, and policy by rule/discretion, indicate whether the policy...
Using the concepts of fiscal/monetary policies, active/passive policies, and policy by rule/discretion, indicate whether the policy is a monetary or a fiscal policy, an active or a passive policy, and a policy by rules or with discretion for each of the following policies a.he central bank follows a policy of allowing the money supply to grow at a constant 4 percent per year; b. the government follows a policy of keeping government spending over a calendar year equal to government...
6) Let’s try to understand the long-run and short-run implications of monetary policy issues. Let’s assume...
6) Let’s try to understand the long-run and short-run implications of monetary policy issues. Let’s assume inflation is currently 2% and that monetary policy has an inflation targeting rule that makes desired (targeted) inflation also 2%. Finally, suppose the equilibrium real interest rate in the economy is 1% and that “beta” in the Phillips curve is 1.2. a) In the long-run, the output gap should be 0% and there should be no shocks to inflation. In that situation what will...
Assume the central bank decides to move and close the GDP gap (inflationary and recessionary )instead...
Assume the central bank decides to move and close the GDP gap (inflationary and recessionary )instead of fiscal policy. In what direction will interest rates have to move to close the GDP gap and what type of open market operation will the central bank undertake?
According to the monetary policy rule, under what condition does the real interest rate equal the...
According to the monetary policy rule, under what condition does the real interest rate equal the natural rate of interest? What does the Taylor principle suggest for monetary policy design?
Suppose a country is facing an inflationary gap, and the Central wants to use monetary policy...
Suppose a country is facing an inflationary gap, and the Central wants to use monetary policy to stabilize the economy. What kind of policy should it follow? How will it impact bond prices, interest rates, investment, the exchange rate, net exports, real GDP, and the price level. Illustrate your analysis graphically with explanations.