A series of oil price increases in the 1970s drove the U.S. economy into stagflation. In response to these shocks, Paul Volcker, an inflation hawk and chairman of the Fed at the time, decided to __ bonds to sharply ______ its target for the Federal Funds Rate sell, decrease buy, decrease sell, increase buy, increase

Use the Fed rule-of-thumb to predict the Fed's target for the federal funds rate and the real target interest rate t for each of the following scenarios if its estimate of the neutral real interest rate is 2%. a. A recession hits the economy, causing output to fall to 0.75% below potential output and inflation to fall to 1%. Federal funds target rate % Federal funds target rate b. An increase in consumer and business confidence pushes output to 2% above potential output, while inflation rises to 3.5%. Target real interest rate: % Target real interest rate: % %

2. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes the quantity of money supplied. Suppose the price level decreases from 90 to 75. Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level on the market for money. 12 Money Supply 10 Money Demand Money Supply MD1 2 MD2 10 20 30 40 50 60 MONEY (Billions of dollars) INTEREST RATE (Percent)

Economics 8. The Taylor Rule and inflation Suppose the initial inflation rate and inflation target are both 2%, that the real federal funds rate is 2%, and that the economy is at the full employment level of output. According the Taylor Rule, the federal funds target should be Suppose now that the inflation rate changes to 4%. The Taylor Rule now prescribes that the federal funds target should be Next, suppose that economists predict that the economy would be at full employment at a level of $18.50 trillion. However, the actual GDP in the United States is $17 trillion. Assuming that the inflation rate is still 4%, the Taylor Rule prescribes that the federal funds target should be Based on the Taylor Rule, the Fed's target for the fed funds rate can never be negative. O True O False