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Chapter 13 Macro (24 Econ)

Work It Out
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You must read each slide, and complete any questions on the slide, in sequence.

In 2012, U.S. inflation was 2.1% and output was 4.8% below its long-run potential. Three years later, in 2015, U.S. inflation fell to 0.4% due to falling energy prices, and output improved to 1.8% below its long-run potential.

A. Assume the inflation target is 2%. Using the Taylor rule, the federal funds target in 2012 is percent (round to two decimal places if necessary).
Incorrect! Using the Taylor rule, the federal funds target rate is 1.75%. Recall the equation for the Taylor rule, and calculate the value.
Federal Funds Target Rate = 2 + Current Inflation Rate + (1/2) (Inflation Gap) + (1/2)(Output Gap) = 2 + 2.1 + 0.5(2.1 – 2) + 0.5(–4.8) = 1.75%.
For further review, see section “The Federal Funds Target and the Taylor Rule”.
Correct! Using the Taylor rule, the federal funds target rate is 1.75%. Recall the equation for the Taylor rule, and calculate the value.
Federal Funds Target Rate = 2 + Current Inflation Rate + (1/2) (Inflation Gap) + (1/2)(Output Gap) = 2 + 2.1 + 0.5(2.1 – 2) + 0.5(–4.8) = 1.75%.
For further review, see section “The Federal Funds Target and the Taylor Rule”.
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      B. If the actual federal funds rate was 0.1% in 2012, the Taylor rule _____ estimated the target.

      		A.
      		B.
      		C.
      		D.
      Incorrect! The federal funds target rate from Part a was calculated to be 1.75%. The actual rate was 0.1%. Thus, the Taylor rule greatly overestimated the target rate. The Fed kept interest rates far below the Taylor rule estimate because the economy was still recovering from a severe recession, and the Fed did not want to risk another recession before the economy fully recovered.
      For further review, see section “The Federal Funds Target and the Taylor Rule”.
      Correct! The federal funds target rate from Part a was calculated to be 1.75%. The actual rate was 0.1%. Thus, the Taylor rule greatly overestimated the target rate. The Fed kept interest rates far below the Taylor rule estimate because the economy was still recovering from a severe recession, and the Fed did not want to risk another recession before the economy fully recovered.
      For further review, see section “The Federal Funds Target and the Taylor Rule”.
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          In 2012, U.S. inflation was 2.1% and output was 4.8% below its long-run potential. Three years later, in 2015, U.S. inflation fell to 0.4% due to falling energy prices, and output improved to 1.8% below its long-run potential.

          C. Again assuming an inflation target of 2%, what was the federal funds target in 2015 using the Taylor rule? (round to one decimal place if necessary) percent.
          Incorrect! Using the Taylor rule, the federal funds target rate is 0.7%. This is calculated as follows. Federal Funds Target Rate = 2 + Current Inflation Rate + (1/2) (Inflation Gap) + (1/2) (Output Gap) = 2 + 0.4 + 0.5 (0.4 – 2.0) + 0.5 (–1.8) = 0.7%. For further review, see section “The Federal Funds Target and the Taylor Rule.”
          Correct! Using the Taylor rule, the federal funds target rate is 0.7%. This is calculated as follows. Federal Funds Target Rate = 2 + Current Inflation Rate + (1/2) (Inflation Gap) + (1/2) (Output Gap) = 2 + 0.4 + 0.5 (0.4 – 2.0) + 0.5 (–1.8) = 0.7%. For further review, see section “The Federal Funds Target and the Taylor Rule.”
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              D. If the actual federal funds rate was 0.4% in 2015, the Taylor rule did a _____ job predicting interest rates compared with 2012.

              		A.
              		B.
              		C.
              Incorrect! The actual federal funds rate in 2012 was 0.1% while the estimated target rate was 1.75%. In 2015, the actual federal funds rate was 0.4% while the estimated target rate was 0.7%. In 2015, the actual federal funds rate was much closer to the target rate using the Taylor rule. The main reason is that inflation fell in 2015, which justified a lower federal funds target rate to stimulate economic growth.
              For further review, see section “The Federal Funds Target and the Taylor Rule”.
              Correct! The actual federal funds rate in 2012 was 0.1% while the estimated target rate was 1.75%. In 2015, the actual federal funds rate was 0.4% while the estimated target rate was 0.7%. In 2015, the actual federal funds rate was much closer to the target rate using the Taylor rule. The main reason is that inflation fell in 2015, which justified a lower federal funds target rate to stimulate economic growth.
              For further review, see section “The Federal Funds Target and the Taylor Rule”.
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