Question

Asked Nov 4, 2019

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The new chairman of the Ionian Central Bank (ICB) is preparing for her first board meeting. She is expected to recommend a monetary policy for the board to pursue. She decides to use the Taylor rule, which was originally developed for the U.S. Federal Reserve.

Ionia's potential GDP is 100 million drachma, but current GDP is 94 million94 million . What is Ionia's output gap?

Ionia's output gap:

%

Inflation is running at 5%5% , but the chairman considers an inflation rate of 3% to be a reasonable goal. What is Ionia's inflation gap?

Ionia's inflation gap:

%

The Taylor rule helps the chairman to determine the target

discount rate.

inflation rate.

fed funds rate.

Calculate this target rate for Ionia, according to the Taylor rule.

target rate:

%

The current rate is 4%, so the chairman recommends

buying securities.

selling securities.

Step 1

The output gap is the difference between the actual GDP and the potential GDP. Lonia’s output gap is equal to -4% where actual GDP is less than the potential GDP.

Step 2

The inflation gap is the difference between the current inflation and reasonable inflation rate. With the provided information, lonia’s inflation gap is equal to 2%.

Inflation gap = current inflation rate – reasonable inflation rate

Inflation gap = 5% - 3%

Inflation gap = 2%

Step 3

Taylor’s rule is used by the chairman to determine the targeted **fed fund rate** where fed fund rate is the rate for interbank lending dot the short term.

According to Taylor’s Rule, lonia targe...

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