just question b and c t the inflation target does not change)? e down the equati

Question

just question b and c

t the inflation target does not change)? e down the equation for the Taylor rule for monetary policy. Explain what each term uation means, in one sentence. ose the Fed is following the Taylor rule. b Supp ose the growth rate of potential output is 3 percent, the output gap is -6 the weights on the output gap and inflation gap are 2 percent, the Fed believes the equilibrium real federal funds rate is 3 percent, and the inflation rate has been 2 percent over the past year. At what level does the Fed set the federal funds rate? percent, each 2, the Fed's inflation target is c Suppose the Fed thinks that the equilibrium federal funds rate is 3 percent, as in part b above, but in fact the equilibrium real fed funds rate is 4 percent. What do you think will happen to the inflation rate in the long run?

Explanation / Answer

    i = r* + pi + 0.5 (pi-pi*) + 0.5 (y-y*)

    Where:

    i = nominal fed funds rate

    r* = real federal funds rate I =

    pi = rate of inflation

    p* = target inflation rate

    Y = logarithm of real output

    y* = logarithm of potential output

    B)

    I = .03+.02+0.5*(0.02-0.02)+0.5(0.06-0.03)

    i = 0.065 = 6.5 %

    C)

    Pi = i-r*-0.5*(Pi-P*)-0.5*(y-y*)

    Pi = 0.065-0.04-0.5*0+0.5*(0.03) = 0.04 = 4%
   

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