First, because economic data are released with a lag and subject to subsequent revisions, Figure 1 is Figure 1 plots actual federal funds rates against rates determined by the Taylor rule from 2000 to 2008. Based on this approach, Taylor (2012) argues that the Fed followed the Taylor rule quite closely until around 2003. ff t = π + ff *r + ½(π gap) + ½(Y gap) ff t = 3 + 2 + ½(1) + ½(0) ff t = 5.5 The Federal Reserve in the United States and Central Bankers all over the world generally have a very important role in the economies of their countries: they set the short-term nominal interest rate. 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22-10-5 0 5 10 15-10-5 0 5 10 15 1%. In 1979, for ex-ample,the rule recommended a high funds rate mainly be-cause inflation was quite high, and to a lesser extent, because real GDP exceeded its potential level by a small amount. Question: Question 4 2 Pts According To The Taylor Rule What Should Be The Target Federal Funds Rate If The Target Inflation Rate Is 2% And The Current Inflation Rate Is 6% And Output Is 4% Below Potential GDP? One way to analyse the importance of the Taylor rule is simply to consider the correlation between the original Taylor rule and the actual Federal Fund's Rate. Figure 1. rules. The Taylor Rule takes the form: r = r* + 1.5(p - 2) + 0.5y. This figure should not be used to directly evaluate actual policy, for two reasons. Interestingly, the figure also shows that during the current expansion, the actual federal funds target rate has been consistently below the rate suggested by the Taylor rule. The Taylor rule is one kind of targeting monetary policy used by central banks.The Taylor rule was proposed by the American economist John B. Taylor, economic adviser in the presidential administrations of Gerald Ford and George H. W. Bush, in 1992 as a central bank technique to stabilize economic activity by setting an interest rate.. The Taylor rule is an interest rate forecasting model, which was introduced in 1993 by Stanford economist John Taylor. O 6% O 2% O 8% Question 5 2 Pts Which Statement Does NOT Describe The Keynesian Monetary Transmission Mechanism? The Taylor rule is an equation John Taylor introduced in a 1993 paper that prescribes a value for the federal funds rate—the short-term interest rate targeted by the Federal Open Market Committee (FOMC)—based on the values of inflation and economic slack such as the output gap or unemployment gap. Iterations of the Taylor Rule. So if the inflation target was 2 percent, actual inflation was 3 percent, output was at its potential, and the real federal funds rate was 2 percent, the Taylor Rule suggests that the fed funds target should be. higher level of the recommended funds rate. Using Taylor's rule (Target federal funds rate = 2 + current inflation + ½(inflation gap) +½(output gap)), when there is no output gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal funds rate should be. The rule suggests that the Fed funds rate should be much higher. In the equation, r is the prescribed funds rate target, r* (often referred to by Fed officials as “r-star”) denotes the long-run or “neutral” level of the federal fund rate, p - 2 measures the deviation of inflation p from the 2% target, and y is the output gap. FEDERAL FUNDS RATE: ACTUAL vs TAYLOR RULE (percent) Federal Funds Rate Actual (0.09) Taylor Rule (1.04) Source: Federal Reserve Board and Bureau of Economic Analysis.

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