Question

Suppose the unemployment rate rises above the natural rate of unemployment. According to the Taylor rule, should the fed funds rate target be set above or below the neutral fed funds rate?

Answer #1

The Taylor Rule is based on three primary factors -

1. Actual employment as compared to natural rate of employment

2. Short-term interest rate being consistent with full employment

3. Targeted inflation as compared to actual inflation

In the given scenario, the unemployment rate rises above the natural rate of unemployment. This implies that the economy is in a slowdown or recession.

Therefore, according to Taylor Rule, **the fed funds rate
target should be set below the neutral fed fund rate**.

It is important to remember that at neutral fed fund rate, the actual employment is in-sync with natural employment. When unemployment rises, the actual employment goes below the natural employment and hence expansionary monetary policy is recommended as per Taylor Rule. This includes setting rates below the neutral fed fund rate.

Suppose the Fed commits itself to the use of the Taylor rule?
(shown below) to set the federal funds rate. Federal funds rate
equals Long minus run target plus 1.5 left parenthesis Inflation
rate minus Inflation target right parenthesis plus 0.5 left
parenthesis Output gap right parenthesis Suppose the Fed has set
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Suppose that inflation is 2 percent, the Federal funds rate is 4
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According to the Taylor rule, in what direction and by how much
should the Fed change the real Federal funds rate?

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+ ?(? − ? ∗ ) + ?? ? 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
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21. the increase in excess reserves that occured as a result of
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b. rendered open-market operations ineffective.
c. caused the Fed to set a negative nominal interest rate target
for the federal funds rate.
d. prevented the Fed from taking any further action to increase
the money supply
22. What does it mean economists say that the Fed has attempted
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a....

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...

Suppose that the natural rate of interest is 2 percent and the
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percent and the rate of real GDP growth is 3 percent above its
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3. When the
unemployment rate is above the natural rate then
inflationary expectations fall and we move to lower short run
Phillip’s curves. The opposite occurs when we are operating below
the natural rate. You must draw a graph for this
question.
4. Excess
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out this money we are going to experience
hyperinflation.
5. Graph only. Label Axes,
all curves and equilibrium. Explain briefly every curve
shift....

Fully describe the concept of the natural rate of
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Use the Fed rule-of-thumb to predict how the
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b. An increase in consumer and business confidence pushes the
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In this question we are going to address whether the Fed and
Alan Greenspan kept interest rates too low for too long following
the 2001 recession according to two rules: The original Taylor Rule
and the Mankiw Rule
Use the table below to answer the following questions.
FF - the federal funds rate
PCE INF = PCE inflation
PCE CORE = the core rate of PCE inflation
GDP = real GDP
GDP POT = potential (real) GDP
UR = the...

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