6) Let’s try to understand the long-run and short-run implications of monetary policy issues. Let’s assume...

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6) Let’s try to understand the long-run and short-run implications of monetary policy issues. Let’s assume...

6) Let’s try to understand the long-run and short-run implications of monetary policy issues. Let’s assume inflation is currently 2% and that monetary policy has an inflation targeting rule that makes desired (targeted) inflation also 2%. Finally suppose the equilibrium real interest rate in the economy is 1% and that “beta” in the Phillips curve is 1.2.

a) In the long-run, the output gap should be 0% and there should be no shocks to inflation. In that situation what will be inflation expectations, the inflation gap, and what will be the targeted federal funds rate? [Hint: use the Phillips curve and Taylor rule.]

b) Now suppose it is the short-run and the output gap is 2%, based on the Phillips curve, what would be the inflation rate now?

c) With the output gap at 2% and your answer for the inflation rate from part b), what is the federal funds rate target according to the Taylor rule?

d) Suppose that in the marketplace the actual federal funds rate is 3%, what would Professor Taylor say about this rate compared to what you calculated in part c).

business economics

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6) Let’s try to understand the long-run and short-run implications of monetary policy issues. Let’s assume...

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6) Let’s try to understand the long-run and short-run implications of monetary policy issues. Let’s assume...