A) Consider the Taylor rule: rt = (s1)[rt−1] + (s2)[rn + ayY˜+ aπ(πt πT )]. Assume target inflation at 2% and natural rate of interest at 1.8%. (a) If output gap increase by 1.5% and actual inflation to 4%, how much will be the interest rate increase from 2% if the central bank gives twice more weight to output gap as compared to inflation targeting weight of 0.5? Assume s1 = s2 = 0. [Write the Taylor rule first and then compute] b) Which component of this Taylor rule captures smoothness of interest rate changes? and How?
A) Consider the Taylor rule: rt = (s1)[rt−1] + (s2)[rn + ayY˜+ aπ(πt πT )]. Assume target inflation at 2% and natural rate of interest at 1.8%. (a) If output gap increase by 1.5% and actual inflation to 4%, how much will be the interest rate increase from 2% if the central bank gives twice more weight to output gap as compared to inflation targeting weight of 0.5? Assume s1 = s2 = 0. [Write the Taylor rule first and then compute] b) Which component of this Taylor rule captures smoothness of interest rate changes? and How?
Chapter14: Macroeconomic Policy: Tradeoffs, Expectations, Credibility, And Sources Of Business Cycles
Section: Chapter Questions
Problem 19E
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- A) Consider the Taylor rule: rt = (s1)[rt−1] + (s2)[rn + ayY˜+ aπ(πt πT )]. Assume target inflation at 2% and natural rate of interest at 1.8%. (a) If output gap increase by 1.5% and actual inflation to 4%, how much will be the interest rate increase from 2% if the central bank gives twice more weight to output gap as compared to inflation targeting weight of 0.5? Assume s1 = s2 = 0. [Write the Taylor rule first and then compute]
b) Which component of this Taylor rule captures smoothness of interest rate changes? and How?
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