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Chapter 22: Q. 1 (page 584)

Go to https://www.federalreserve.gov/monetarypolicy/ files/FOMC_LongerRunGoals.pdf. Review the FOMC’s document, “Longer-Run Goals and Monetary Policy Strategy.” 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

A measure of real interest rates can be approximated by the Treasury Inflation-Indexed Security, or TIIS. Go to the St. Louis Federal Reserve FRED database, and find data on the five-year TIIS (FII5) and the personal consumption expenditure price index

(PCECTPI), a measure of the price index. Choose “Quarterly” for the frequency setting for the TIIS, and choose “Percent Change From Year Ago” for the unitssetting on (PCECTPI). Plot both series on the samegraph, using data from 2007 through the most currentdata available. Use the graph to identify periods of autonomous monetary policy changes. Briefly explain your reasoning.

Suppose that government spending is increased at the same time that an autonomous monetary policy tightening occurs. What will happen to the position of the aggregate demand curve?

Suppose the monetary policy curve is given by r=1.5+0.75π, 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.

Use an IS curve and an MP curve to derive graphically the AD curve.

Suppose the MP curve is given by r = 2 + p, 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 p = 0, p = 4, and p = 8.

b. Suppose that l increases to l = 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’s distaste for

inflation and the slope of the AD curve?
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