Question

The *Fed rule* equation is used to describe the interest
rate behavior of the Fed. Briefly describe what the *Fed
rule* equation tells us about interest rate setting with
respect to inflation and output?

Answer #1

Use the Fed rule-of-thumb to predict how the
Fed would want to change the federal funds rate and the real
interest rate targets for each of the following scenarios if its
estimate of the neutral real interest rate is 2%.
a. A recession hits the economy leading output to be 0.75% below
potential output and inflation to fall to 1%.
b. An increase in consumer and business confidence pushes the
economy to produce output at 2% above potential output while...

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,...

Imagine you are the chief economist at the Fed and you are
trying to convince the Fed governor that she should follow the
Taylor rule when setting the fed funds rate. "I don't like this
Taylor rule," she says. "I think I can do better than the rule."
"However, with the Taylor rule you do not have to think what to do.
You just observe the inflation rate and the output growth, and set
the interest rate accordingly," you say....

Use the Taylor rule to predict the Fed funds rate in each of the
following situations. a. Inflation is 3 percent, the inflation
target is 4 percent, and output is 3 percent below potential.
Instructions: Enter your response rounded to one decimal place.
percent b. Inflation is 4 percent, the inflation target is 3
percent, and output is 3 percent above potential. Instructions:
Enter your response rounded to one decimal place. percent c.
Inflation is 4 percent, the inflation target...

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?

Given the following Taylor rule:
Target federal funds rate = natural rate of interest + current
inflation + 1/2(inflation gap) +1/2(output gap);
Explain what happens to the real interest rate and why it
happens, each time inflation increases
by 1 percent.

Use the following Taylor rule to calculate what would happen to
the real interest rate if inflation increased by 5 percentage
points. Target federal funds rate = Natural rate of interest +
Current inflation + 1/2(Inflation gap) + 1/2(Output gap)
If inflation goes up by 5 percentage points, the target
(nominal) federal funds rate goes up by ?
percentage points (? percentage points due to the
direct impact of inflation and another ?
percentage points due to an increase in...

Use the following Taylor rule to calculate what would happen to
the real interest rate if inflation increased by 1 percentage
points.
Target federal funds rate = 2 + Current inflation + 1/2
(Inflation gap) + 1/2(Output gap)
If inflation goes up by 1 percentage points, the target federal
funds rate goes up by ___ percentage points ( ___ percentage points
due to the direct impact of inflation and another __ percentage
points due to an increase in the inflation...

Use the following Taylor rule to calculate what would happen to
the real interest rate if inflation increased by 1 percentage
points. Target federal funds rate = Natural rate of interest +
Current inflation + 1/2(Inflation gap) + 1/2(Output gap)
Instructions: Enter your responses rounded to one decimal
place.
If inflation goes up by 1 percentage points, the target
(nominal) federal funds rate goes up by ? percentage points ( ?
percentage points due to the direct impact of inflation...

A. Give the equation of
exchange. For each variable in the equation, explain or
define it briefly.
B. Since 2007 (quant. easing), many
non-Keynesian economists (Classical) have been predicting a rapid
increase in the inflation rate. Why? Use the
equation in your answer.
C. Why do Keynesian economists believe
increasing the money supply is a good idea? Use the
equation in your answer.
D. Use the equation to
explain or illustrate “Friedman’s Rule.”
E. John Taylor had an opinion about
one of the variables in...

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