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Eco – Suppose That The Economy Is Thought To Be 2 Percent Above Potential

Submitted by • November 2, 2018

1. Suppose that the economy is thought to be 2 percent above potential (that is, the output gap is 2 percent) when potential output grows 4 percent per year. Suppose also that the Fed is following the Taylor rule, with an inflation rate of 2 percent over the past year. The federal funds rate is currently 3 percent. The equilibrium real federal funds rate is 3 percent, and the weights on the output gap and inflation gap are 0. 5 each. The inflation target is 1 percent. a Is the federal funds rate currently too high or too low?By how much?Show your work. b Suppose that a year has gone by, output is now just 1 percent above potential, and the inflation rate was 1. 5 percent over the year. What federal funds rate should the Fed now set (assuming that the inflation target does not change)?2. Suppose that the Fed's inflation target is 2%, potential output growth is 3. 5%, and velocity is a function of how much the interest rate differs from 5%: % triangle v=0. 5x(i-5)Suppose that a model of

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