1. This question is based on the article, "Deutsche Bank Issues Stark US Inflation Warning, Seeing Economic Parallels to 1940s, 1970," published on the website of coindesk.com on June 7, 2021. The article summarizes the messages of a report by Deutsche Bank on the potential trends in the U.S. economy and the possible policy responses to them in the next couple of years.

(a)The article suggests that the output gap of the U.S. economy at the end of 2020 stood at about -3% (see the chart in the article) but may rise to 2% (or more) in 2021/2022 (see the grey line in the chart which corresponds to the Deutsche Bank projected baseline[1]). According to the article, what factors may contribute to this dramatic change and thus contribute to inflationary pressures by increasing aggregate demand? Note: Consider factors that impacted consumption (C) and investment (I) and make sure to explain the mechanism of their work. [8]

Answer:

(b)From the material presented in the article, is the Fed following an optimal Taylor rule or deviating from such a rule? What are the risks of deviating from the rule? Please justify your conclusions; and make sure to explain what Taylor Rule is in your response. [10]

Answer:

(c)According to the article, how do U.S. macroeconomic policies under the COVID-19 pandemic compare with the policies adopted in response to the 2008 financial crisis? Note that there was no inflation in the aftermath of the financial crisis. Does the article portray the policy response to the 2008 financial crisis as optimal or sub-optimal? [6]

Answer:

You may also access the full Deutsche Bank report on this issue through this link: https://www.db.com/news/detail/20210607-deutsche-bank-research-warns-of-the-impending-threat-of-rising-inflation?language_id=1