Chapter 31, Problem 1FRQ

a)

To determine

The equation for the Taylor rule

Explanation of Solution

The equation for the Taylor rule is as follows:

Federal funds rate = 1 +(1.5×inflation rate) +(0.5×output gap)

b)

To determine

The compatibility of Taylor rule with the actual behavior of the Fed.

Explanation of Solution

Not quite, but close enough It performs superior than a single metric on its own and has consistently forecasted the course of interest rate shift.

c)

To determine

The fund rate as per the Taylor rule.

Explanation of Solution

A rise in the federal funds rate is expected. The formula states that for every percentage point increase in inflation, the federal funds rate rises by 1.5 percentage points. Alternately, the Taylor rule states that during inflationary times, monetary policy will be contractionary.

d)

To determine

change in the target federal funds rate 

Explanation of Solution

The federal funds rate is going down. A worse recession is indicated by the equation's finding that the federal funds rate falls by 0.5 percentage points for every 1% reduction in the production gap. Alternately, the Taylor rule states that during recessions, monetary policy will be expansionary.