Question 1

If the Federal Reserve tries to target inflation near 2%,the inflation rate is 1.5%,and output is 2.3% below potential GDP,the target federal funds rate according to the Taylor rule is 4.4%.

Accepted Answer

The Taylor rule is expressed as follows:

Target federal funds rate = current inflation rate + equilibrium real interest rate + 0.5(inflation rate deviation from target) + 0.5(output gap deviation from potential)

Thus, if the inflation rate is 1.5% and the target is 2%, the inflation rate deviation from the target is -0.5%. If output is 2.3% below potential GDP, the output gap deviation from potential is -2.3%. Using these numbers and assuming an equilibrium real interest rate of 2%, we get:

Target federal funds rate = 1.5 + 2 + 0.5(-0.5) + 0.5(-2.3) = 2.9%

Therefore, the correct answer is B, the target federal funds rate according to the Taylor rule would be 2.9%, not 4.4%.

Question 2

In September 2012,Norway's central bank said it would delay plans to tighten monetary policy.When the Norges Bank does pursue tighter monetary policy,the Norwegian krone is likely to rise against foreign currencies.

Accepted Answer

When a central bank tightens its monetary policy, it typically raises interest rates, which can attract foreign investors to the currency and increase demand for it, causing the currency to appreciate. Therefore, if Norway's central bank pursues tighter monetary policy, it is likely that the Norwegian krone will rise against foreign currencies.

Question 3

The Taylor rule is the official Fed policy.

Accepted Answer

The Taylor rule is not the official Fed policy but rather a monetary policy guideline proposed by economist John Taylor. The Fed may take the Taylor rule into consideration along with other factors when making policy decisions, but it is not a formal policy.

Question 4

According to the Taylor rule,the higher the inflation rate,other things equal,the lower the federal funds target rate.

Accepted Answer

According to the Taylor rule, the higher the inflation rate, other things being equal, the higher the federal funds target rate should be to combat inflation.

Question 5

The practice of conducting monetary policy in secret can create uncertainty in the markets.

Accepted Answer

When central banks conduct monetary policy in secret, it can create uncertainty and lack of transparency in the markets, leading to potential negative impacts on economic stability and investor confidence. It is, therefore, important for central banks to communicate their policy decisions openly and transparently to the public and financial markets.

Question 6

If the change in aggregate demand is small or temporary,a monetary growth rule will probably function well.

Accepted Answer

A monetary growth rule, such as a fixed rate of increase in the money supply, can be effective in stabilizing the economy when aggregate demand fluctuations are small or temporary. This is because changes in the money supply can have a direct impact on the level of aggregate demand. However, if the change in aggregate demand is large or persistent, other policy tools may be needed to address the underlying causes of the fluctuations.

Question 7

The Fed's inflation target is typically 2%.

Accepted Answer

The Federal Reserve's inflation target is typically 2%.

Question 8

Monetary targeting tends to keep aggregate demand relatively stable.

Accepted Answer

Monetary targeting involves setting a target for the money supply, which can help to keep inflation in check and therefore keep aggregate demand relatively stable.

Question 9

The Federal Reserve uses expansionary policy when output is above potential GDP.

Accepted Answer

The Federal Reserve actually uses contractionary policy when output is above potential GDP, as this can lead to inflation and overheating of the economy. Expansionary policy is used when output is below potential GDP to stimulate economic growth.

Question 10

According to the Taylor rule,the more actual GDP falls below potential GDP,other things equal,the lower the federal funds target rate.

Accepted Answer

According to the Taylor rule, the federal funds target rate should be decreased as actual GDP falls below potential GDP in order to stimulate economic growth.

Question 11

If the Federal Reserve tries to target inflation near 2%,the inflation rate is 3%,and output is 1.3% above potential GDP,the target federal funds rate according to the Taylor rule is 6.15%.

Accepted Answer

According to the Taylor rule, the target federal funds rate would be calculated as follows:

Target federal funds rate = current federal funds rate + 1.5*(inflation rate - target inflation rate) + 0.5*(output gap)

Using the given values:

Target federal funds rate = current federal funds rate + 1.5*(3% - 2%) + 0.5*(1.3%)

Simplifying:

Target federal funds rate = current federal funds rate + 1.5% + 0.65%

Since the Federal Reserve is targeting inflation near 2%, it is likely that the current federal funds rate is already higher than the target federal funds rate. Therefore, the target federal funds rate based on the current conditions would be higher than the current federal funds rate. Based on the given information, the target federal funds rate would be 6.15%, which is higher than the current federal funds rate. Therefore, the statement is true.

Question 12

Economists who believe in monetary targeting believe that the economy is inherently unstable.

Accepted Answer

The answer of Economists who believe in monetary targeting believe...

Question 13

In the long run,the Fed targets full employment,which it considers to be 4% to 5% unemployment.

Accepted Answer

The answer of In the long run,the Fed targets full...

Question 14

A monetary rule is especially appropriate in the case of a major economic shock.

Accepted Answer

A monetary rule, which involves following a defined guideline for monetary policy, might not be flexible enough to respond adequately to a major economic shock, which often requires more adaptive and responsive measures.

Question 15

The Federal Reserve's interest rate target is the level that will generally result in inflationary pressures.

Accepted Answer

The Federal Reserve's interest rate target is set to achieve its mandate of maximum employment and stable prices, which includes keeping inflation in check. The target rate may be adjusted based on economic conditions to achieve this goal, but the objective is not to create inflationary pressures.

Question 16

The Taylor rule states that the federal funds target rate is 2% plus one-half the inflation gap plus one-half the output gap.

Accepted Answer

The Taylor rule suggests setting the federal funds target rate based on three terms: a constant term (often 2%), the inflation gap (the difference between current inflation and the target inflation rate), and the output gap (the difference between actual and potential output). However, it typically involves the entire inflation gap and output gap, not one-half of each.

Question 17

Assume that the economy is in full-employment equilibrium.If an inflation targeting rule is used and a positive demand shock hits the economy,the Fed will undertake an expansionary monetary policy to return the economy to full employment.

Accepted Answer

If a positive demand shock occurs, it typically leads to higher inflation. Under an inflation targeting rule, the Fed would likely implement a contractionary monetary policy to curb inflation, not an expansionary one.

Question 18

If the Fed followed Milton Friedman's monetary rule,it would increase the money supply to fight recession and decrease the money supply to fight inflation.

Accepted Answer

Milton Friedman's monetary rule advocates for a constant growth rate of the money supply, regardless of economic conditions, rather than adjusting it to fight recession or inflation.

Question 19

Inflation targeting would fight both inflation and the recession in the event of an adverse supply shock.

Accepted Answer

Inflation targeting primarily focuses on controlling inflation by adjusting interest rates and does not directly address the underlying causes of a recession, especially in the case of an adverse supply shock which can lead to stagflation (a combination of inflation and recession).

Question 20

A monetary rule would make it difficult to respond to unforeseen consequences.

Accepted Answer

A monetary rule would require strict adherence to a predetermined policy, making it difficult to adjust to unforeseen developments in the economy. This could potentially lead to unintended consequences and hinder the government's ability to respond effectively to changing economic conditions.

Quiz 13: Monetary Policy