Chapter 19, Problem 2DAP

To determine

1. By using the output and inflation gaps for each quarter, the federal funds rate predicted by the Taylor rule and tocompare the current (quarterly average) federal funds rate to the federal funds rate prescribed by the Taylor rule
2. A graph that compares the predicted Taylor rule values with the actual quarterly federal funds rate averages and to ascertain if the Taylor rule prediction fits the average federal funds rate.
3. The limitations of the Taylor rule as a formal policy tool and as to how these limitations help explain the use of nonconventional monetary policy during this period
4. Congress changes the Federal's mandate to a hierarchical one in which inflation stabilization takes priority over output stabilization. Recalculate the predicted Taylor rule value for each quarter since 2000, assuming that the weight on inflation stabilization is ¾ and the weight on output stabilization is ¼. Plot a graph showing the Taylor rule prediction using new ' hierarchical'Taylor rule, and the federal funds rate. Also explain how changing the mandate change the predicted policy paths and how would the federal funds rate be affected by a hierarchical mandate.

Concept introduction:

Fiscal Deficit: It takes into consideration the gap in government's budget; a gap that arises in any financial year when the government's total expenditure exceeds its total income in that year and consequently it borrows money to cover that gap.