Question: 4. (40 points) Taylor Rule 4a. (8 points) Monetary Policy along an AD Curve Reflecting a Fixed Policy (Taylor) Rule. In this section assume that

4. (40 points) Taylor Rule 4a. (8 points) Monetary Policy along an AD Curve Reflecting a Fixed Policy (Taylor) Rule. In this section assume that the central bank follows the following prescription for the nominal federal funds rate: nominal federal funds (FF) rate = Inflation + the equilibrium reai federal funds + 1/2(output gap) + 1/2(inflation gap) where the inflation target is 2 percent. Use this target to calculate the inflation gap. Suppose inflation = 8%; the equilibrium real federal funds = 3%; the inflation target is 2%; and output = potential output. Calculate the following (8 points): Inflation Gap 6' percent Output Gap 0 percent Nominal FFTarget Rate I Lp percent Neutral Nominal FF Rate I I percent At the calculated nominal federal funds rate target (the one prescribed by the Taylor Rule), is the stance of monetary policy expansionary, contractionary, or neutral? Why? (2 points)

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