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Chapter 22: Q. 1 (page 584)

Go to https://www.federalreserve.gov/monetarypolicy/ files/FOMC_LongerRunGoals.pdf. Review the FOMC鈥檚 document, 鈥淟onger-Run Goals and Monetary Policy Strategy.鈥� Explain why these goals are consistent with the Taylor principle.

Short Answer

Expert verified

Fed achieves its objectives and maintains price stability through implementing an effective monetary policy and adhering to the Taylor principle.

Step by step solution

01

Step : 1 Mean of FOMC

The Federal Open Market Committee (FOMC) holds meetings in which it reviews monetary and economic conditions to assess the risk to long terms goals for stability and growth and to determine the correct policy stance.

02

Step : 2 Taylor's principle 

When inflation exceeds the target percentage or GDP exceeds its potential, interest rates should be raised, according to Taylor's principle. If the Fed does not follow this guideline and the inflation rate exceeds the interest rate, hyperinflation and price instability may result.

In the document, the FOMC has mentioned that it aims to keep the inflation rate at 2% and keep the long-term interest rates moderate. This is consistent with the Taylor principle as the principle states that the nominal interest rate should be increased more than the inflation rate so that the real interest rate increases.

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Most popular questions from this chapter

When the inflation rate increases, what happens to the federal funds rate? Operationally, how does the Fed adjust the federal funds rate?

Consider an economy described by the following:

C = \(4 trillion

I = \)1.5 trillion

Suppose the monetary policy curve is given by r=1.5+0.75蟺, and the IS curve is given by Y=13-r.

a. Calculate an expression for the aggregate demand curve.

b. Calculate the real interest rate and aggregate output when the inflation rate is 2%, 3%, and 4%.

c. Draw graphs of the IS, MP, and AD curves, labeling the points from part (b) on the appropriate graphs.

Suppose the MP curve is given by r=2+蟺and the IS curve is given by Y = 20 - 2r.

a. Derive an expression for the AD curve, and draw a graph labeling points at 蟺=0,蟺=4,蟺=8

b. Suppose that 位increases to 位=2. Derive an expression for the new AD curve, and draw the new AD curve using the graph from part (a).

c. What does your answer to part (b) imply about the relationship between a central bank鈥檚 distaste for inflation and the slope of the AD curve?

Assume that the monetary policy curve is given byr=1.5+0.75蟺.

a. Calculate the real interest rate when the inflation rate is2%,3%,and4%.

b. Draw a graph of the MP curve, labeling the points from part (a).

c. Assume now that the monetary policy curve is given by r=2.5+0.75蟺.Does the new monetary policy curve represent an autonomous tightening or loosening of monetary policy?

d. Calculate the real interest rate when the inflation rate is2%,3%,and4%, and draw the new MP curve, showing the shift from part (b).
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