Olivier Blanchard, the French economist and the previous chief economist at the International Monetary Fund (IMF), believes that the target inflation rate should be higher than 2 percent. He proposes 4 percent, rather than Taylor's 2 percent. According to Blanchard, this provides more flexibility for the Fed to fight severe recessions. Let's see what he means using our Taylor Rule. First, let's assume that the target inflation rate in 2 percent as before. Let's suppose that because of the Fed's successful policy, the actual inflation rate is also 2 percent, equal to the target. Now assume the following: Current Actual Inflation Rate = 2% Potential Real GDP = 100,000 Actual Real GDP = 90,000 (we have a 10% GDP gap, which is horrible!) According to the Taylor Rule (with the 2% target inflation rate), the Fed should set the federal funds percent (just write down the federal funds rate that comes out of the rate at formula). In that case, the real federal funds rate will equal Ask yourself: Is this scenario possible? Next, let's assume that the target inflation rate in 4 percent as proposed by Blanchard. Let's suppose that because of the Fed's successful policy, the actual inflation rate is also 4 percent, equal to the target. Now assume the following: percent. Current Actual Inflation Rate = 4% Potential Real GDP = 100,000 Actual Real GDP = 90,000 (we have a severe recession, as before!) According to the Taylor Rule (with the 4% target inflation rate), the Fed should set the federal funds percent. In that case, the real federal funds rate will equal rate at percent. Ask yourself: Is this scenario possible?
Olivier Blanchard, the French economist and the previous chief economist at the International Monetary Fund (IMF), believes that the target inflation rate should be higher than 2 percent. He proposes 4 percent, rather than Taylor's 2 percent. According to Blanchard, this provides more flexibility for the Fed to fight severe recessions. Let's see what he means using our Taylor Rule. First, let's assume that the target inflation rate in 2 percent as before. Let's suppose that because of the Fed's successful policy, the actual inflation rate is also 2 percent, equal to the target. Now assume the following: Current Actual Inflation Rate = 2% Potential Real GDP = 100,000 Actual Real GDP = 90,000 (we have a 10% GDP gap, which is horrible!) According to the Taylor Rule (with the 2% target inflation rate), the Fed should set the federal funds percent (just write down the federal funds rate that comes out of the rate at formula). In that case, the real federal funds rate will equal Ask yourself: Is this scenario possible? Next, let's assume that the target inflation rate in 4 percent as proposed by Blanchard. Let's suppose that because of the Fed's successful policy, the actual inflation rate is also 4 percent, equal to the target. Now assume the following: percent. Current Actual Inflation Rate = 4% Potential Real GDP = 100,000 Actual Real GDP = 90,000 (we have a severe recession, as before!) According to the Taylor Rule (with the 4% target inflation rate), the Fed should set the federal funds percent. In that case, the real federal funds rate will equal rate at percent. Ask yourself: Is this scenario possible?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Olivier Blanchard, the French economist and the previous chief economist at the International
Monetary Fund (IMF), believes that the target inflation rate should be higher than 2 percent. He
proposes 4 percent, rather than Taylor's 2 percent. According to Blanchard, this provides more
flexibility for the Fed to fight severe recessions. Let's see what he means using our Taylor Rule.
First, let's assume that the target inflation rate in 2 percent as before. Let's suppose that because of
the Fed's successful policy, the actual inflation rate is also 2 percent, equal to the target.
Now assume the following:
Current Actual Inflation Rate = 2%
Potential Real GDP = 100,000
Actual Real GDP = 90,000 (we have a 10% GDP gap, which is horrible!)
According to the Taylor Rule (with the 2% target inflation rate), the Fed should set the federal funds
rate at
percent (just write down the federal funds rate that comes out of the
formula). In that case, the real federal funds rate will equal
Ask yourself: Is this scenario possible?
Next, let's assume that the target inflation rate in 4 percent as proposed by Blanchard. Let's
suppose that because of the Fed's successful policy, the actual inflation rate is also 4 percent, equal
to the target.
Now assume the following:
Current Actual Inflation Rate = 4%
Potential Real GDP = 100,000
Actual Real GDP = 90,000 (we have a severe recession, as before!)
According to the Taylor Rule (with the 4% target inflation rate), the Fed should set the federal funds
percent. In that case, the real federal funds rate will equal
rate at
percent.
percent.
Ask yourself: Is this scenario possible?
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