Conducting monetary policy so that the FF rate = $\pi$ + 0.5( $\pi$ - 2) + 0.5 (GDP gap), where the FF rate is the nominal federal funds interest rate, $\pi$ is the annual inflation rate, and GDP gap is the percentage shortfall of real GDP from its natural level, is an example of :
A) an active policy rule.
B) a passive policy rule.
C) discretionary policy.
D) an automatic stabilizer.

Question

Conducting monetary policy so that the FF rate =  $\pi$ + 0.5( $\pi$ - 2) + 0.5 (GDP gap), where the FF rate is the nominal federal funds interest rate,  $\pi$ is the annual inflation rate, and GDP gap is the percentage shortfall of real GDP from its natural level, is an example of :
A) an active policy rule.
B) a passive policy rule.
C) discretionary policy.
D) an automatic stabilizer.

Quizplus · Accepted Answer

This is an example of an active policy rule because it explicitly sets a target for the federal funds rate based on specific economic conditions (inflation rate and GDP gap), and requires the central bank to actively adjust the FF rate in order to achieve that target. Passive policy rules, on the other hand, would simply let market forces determine interest rates without any specific guidance or intervention from the central bank. Discretionary policy involves using subjective judgement to adjust policy as needed, rather than following a predetermined formula like this rule. Finally, while this rule does incorporate automatic stabilizers (the GDP gap component), it is not primarily an example of such stabilizers, as it still requires active policy adjustments in order to achieve the desired outcome.

Conducting Monetary Policy So That the FF Rate = π\piπ + 05

Conducting Monetary Policy So That the FF Rate = $\pi$ + 05