Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 16: Q8. (page 347)

In 2009, the inflation rate reached a negative 0.4 percent while the unemployment rate hit 10 percent. If the target inflation rate was 2 percent and the full-employment rate of unemployment was 5 percent, what value does the Taylor Rule predict for the Fed’s target interest rate back then? Would that rate have been possible given the zero lower bound problem?

a. negative 4.6 percent, not possible.

b. positive 0.4 percent, possible.

c. negative 5.6 percent, not possible.

d. positive 6.4, possible.

Short Answer

Expert verified

The correct option is‘ a. negative 4.6 percent, not possible’.

Step by step solution

01

Step 1. Reason for the correct option 

The Taylor rule suggests the following formula for the Fed’s target interest rate:

Fed target interest rate = 2 + current actual inflation rate + 0.5 × inflation gap – 1.0 × unemployment gap,where inflation gap = actual – target inflation rate, and

Unemployment gap = actual – target unemployment rate.

Therefore,

Inflation gap = -0.4-2=-2.4

unemployment gap = 10-5=5, and

target Interest rate =2+-0.4+0.5×-2.4-1.0×5=-4.6.

The zero-bound problem occurs when the interest rates are very near to zero or zero itself. As the rates are very far from zero, there will be no zero-bound problem in this case.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

True or False: In the United States, monetary policy has two key advantages over fiscal policy: (1) isolation from political pressure and (2) speed and flexibility.

Refer to Table 16.2 and assume that the Fed’s reserve ratio is 10 percent and the economy is in a severe recession. Also, suppose that the commercial banks are hoarding all excess reserves (not lending them out) because they fear loan defaults. Finally, suppose that the Fed is highly concerned that the banks will suddenly lend out these excess reserves and possibly contribute to inflation once the economy begins to recover and confidence returns. By how many percentage points does the Fed need to increase the reserve ratio to eliminate one-third of the excess reserves? What is the size of the monetary multiplier before and after the change in the reserve ratio? By how much would banks’ lending potential decline as a result of the increase in the reserve ratio?

(1) Reserve Ratio, %

(2)

Checkable Deposits, \(

(3)

Actual Reserves, \)

(4) Required Reserves, \(

(5) Excess Reserve, \)

(3-4)

(6)

Money-Creating Potential of Single Bank, \(=5

(7)

Money-Creating Potential of Banking System, \)

10

20

25

30

20,000

20,000

20,000

20,000

5,000

5,000

5,000

5,000

2,000

4,000

5,000

6,000

3,000

1,000

0

-1,000

3,000

1,000

0

-1,000

30,000

5,000

0

-3,333

Define Monetary Policy?

A bank currently has \(100,000 in checkable deposits and \)15,000 in actual reserves. If the reserve ratio is 20 percent, the bank has ______ in money-creating potential. If the reserve ratio is 14 percent, the bank has _______ in money-creating potential

a. \(20,000; \)14,000

b. \(3,000; \)2,100

c. −\(5,000; \)1,000

d. \(5,000; \)1,000

Who are the MPC?
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free