1 text solutions and grades 15 february

Page 1

Part I Exercise 1 a) Define and explain the neutral (or natural) rate of interest, both in the neo-classical theory and in the Taylor rule. 4 points Explain and draw the goods and bonds market equilibria in the neoclassical model and explain why that interest rate is the one that brings in equilibrium both markets. Explanation of the Taylor rule where that rate is the one where the two inflation and output gaps close. b) Explain why, with a lower neutral interest rate, the policy rate will hit more often the effective (or zero) lower bound. 3 points In order to have an easy monetary policy, the policy rate must be lower than the neutral interest rate: the lower is the neutral rate the smaller will be the monetary space to act over the ZLB. c) Explain which are the innovations in the revisions to the Fed’s monetary policy framework and the motivations for such innovations. 4 points “The revised statement emphasizes that - maximum employment is a broad and inclusive goal. This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities. Recognizing the economy's ability to sustain a robust job market without causing an unwanted increase in inflation, the statement says that our policy decisions will be informed by our "assessments of the shortfalls of employment from its maximum level" rather than by "deviations from its maximum level."This means that we will not tighten monetary policy solely in response to a strong labor market. - To counter the adverse economic dynamics that could ensue from declines in inflation expectations in an environment where our main policy tool is more frequently constrained, we now explicitly seek to achieve inflation that averages 2 percent over time. This means…