Question

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?

Answer #1

According to the monetary policy rule when there is neither inflation nor deflation in the economy in this condition the real interest rate equal to the natural rate of interest.

The Taylor Rule suggests that the Federal Reserve should raise rates when inflation is above target or when gross domestic product (GDP) growth is too high and above potential. It also suggests that the Fed should lower rates when inflation is below the target level or when GDP growth is too slow and below potential.

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?

What is meant by a Taylor rule? Describe rule based monetary
policy, and the pros and cons of such an approach?
Then describe how the Taylor rule approach affects central bank
credibility

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...

Which of the following is NOT an alternative rule for monetary?
policy?
A.
a natural unemployment rate targeting rule
B.
an inflation rate targeting rule
C.
a money targeting rule
D.
a gold price targeting rule
E.
a monetary base instrument rule

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...

What is the general case for preferring discretionary monetary
policy to a monetary policy rule?

What is the general case for preferring a monetary policy rule
to discretionary monetary policy?

8.
Conducting monetary policy so that the federal funds rate = p +
0.5(p – 2) + 0.5 (GDP gap), where the federal funds rate is the
nominal federal funds interest rate, p is the annual inflation
rate, and GDP gap is the percentage shortfall of real GDP from its
natural level, is an example of:
A)
an active policy rule.
B)
a passive policy rule.
C)
discretionary policy.
D)
an automatic stabilizer.

The main advantage of using the interest rate, rather than the
money supply, as the policy instrument in the dynamic
AD–AS model is that it is more realistic. Today, most
central banks, including the Federal Reserve, set a short-term
target for the nominal interest rate. Keep in mind, though, that
hitting that target requires adjustments in the money supply. For
this model, we do not need to specify the equilibrium condition for
the money market, but we should remember that...

The main advantage of using the interest rate, rather than the
money supply, as the policy instrument in the dynamic
AD–AS model is that it is more realistic. Today, most
central banks, including the Federal Reserve, set a short-term
target for the nominal interest rate. Keep in mind, though, that
hitting that target requires adjustments in the money supply. For
this model, we do not need to specify the equilibrium condition for
the money market, but we should remember that...

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