money and banking practice question 1
17. Classify each of the following as either a policy instrument or an intermediate target, andexplain your choice.
a. The ten-year Treasury bond rate
b. The monetary base
c. M1
d. The fed funds rate
23. What does the Taylor rule imply that policymakers should do to the fed funds rate under thefollowing scenarios?
a. Unemployment rises due to a recession.
b. An oil price shock causes the inflation rate to rise by 1% and output to fall by 1%.
c. The economy experiences prolonged increases in productivity growth while actual outputgrowth is unchanged.
d. Potential output declines while actual output remains unchanged.e. The Fed revises its (implicit) inflation target downward.
24. If the Fed has an interest-rate target, why will an increase in the demand for reserves lead to arise in the money supply? Use a graph of the market for reserves to explain.
25. Since monetary policy changes made through the fed funds rate occur with a lag,policymakers are usually more concerned with adjusting policy according to changes in theforecasted or expected inflation rate, rather than the current inflation rate. In light of this,suppose that monetary policymakers employ the Taylor rule to set the fed funds rate, wherethe inflation gap is defined as the difference between expected inflation and the targetinflation rate. Assume that the weights on both the inflation and output gaps are ½ theequilibrium real fed funds rate is 2%, the inflation rate target is 2%, and the output gap is1%.
a. If the expected inflation rate is 4%, then at what target should the fed funds rate be setaccording to the Taylor rule?
b. Suppose half of Fed economists forecast inflation to be 3%, and half of Fed economistsforecast inflation to be 5%. If the Fed uses the average of these two forecasts as itsmeasure of expected inflation, then at what target should the fed funds rate be setaccording to the Taylor rule?
c. Now suppose half of Fed economists forecast inflation to be 0%, and half forecastinflation to be 8%. If the Fed uses the average of these two forecasts as its measure ofexpected inflation, then at what target should the fed funds rate be set according to theTaylor rule?
d. Given your answers to parts (a)–(c) above, do you think it is a good idea for monetarypolicymakers to use a strict interpretation of the Taylor rule as a basis for setting policy?Why or why not?
