Chapter 19, Problem 23Q

To determine

The implications of the Taylor rule that the policymakers should do to the federal funds rate under the following scenarios

1. Unemployment rises due to a recession.
2. An oil price shock causes the inflation rate to rise by 1% and the output to fall by 1%.
3. The economy experiences an increase in productivity growth while the actual output growth remains unchanged.
4. Potential output declines while actual output remains unchanged.
5. The Federal revises its (implicit) inflation target downwards.

Concept introduction:

As per the Taylor rule, the federal funds rate should be equivalent to the sum of the inflation rate,the “equilibrium” real federal funds rate and the weighted average of the inflation gap and the output gap.

Hence, mathematically: Federal fund rate target = InflationRate + Equation real fed funds rate + $\frac{1}{2}$ (inflation gap) + $\frac{1}{2}$ (output gap)