Assume the Fed uses the following Taylor Rule to set the target value for iff

iff = pi + 2 + (1) (output gap) + (0.5)*(pi – pi_target). You are also told that

Target (full employment) output is 100 and actual output is 98.

The target inflation rate is 2.0% and actual inflation rate is assumed to be 4%.

The current federal funds rate is 3.0%.

Assume the discount rate is 7% and the interest rate on reserves is 0.5%.

Which of the following Fed actions are consistent with its policy objectives (based on what the Taylor Rule recommends)?

A) The Fed should engage in an open market sale of bonds unless it expected banks to simultaneously decrease (shift) their demand for reserves. In that case, the Fed should engage in an open market purchase of bonds.

B) The Fed should engage in an open market sale of bonds. This would still be the proper action even if the Fed expected banks to simultaneously decrease (shift) their demand for reserves.

C) The Fed should cut the required reserve ratio especially if it expected banks to simultaneously decrease (shift) their demand for reserves.

D) Two of the above are consistent with the Fed’s policy objectives based on the Taylor rule.

Answer rating: 100% (QA)

The detailed answer for the above question is provided below The answer is B The Fed should engage i... View the full answer