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You are a junior bond trader at Morgan Stanley. Your boss asks you write a short report where you explain the Taylor Rule to your
You are a junior bond trader at Morgan Stanley. Your boss asks you write a short report where you explain the Taylor Rule to your colleagues and describe how it can be a helpful guide to understand how the FED sets monetary policy. Your report should contain the following elements: a) A well labeled and professional looking graph ofthe Taylor Rule and the federal funds rate on a Quarterly freguency from 197001 to 202103. To do this, you will rst need to download the following data from FRED into Excel: real GDP (GDPCl); real potential GDP (GDPPOT); core consumer prices (J CXFE]; and the federal funds rate (FEDFUNDS). Select 'average' as the aggregation method. Once all is downloaded in Excel, compute the_output gap as 100 x ln(GDPC1/GDPPOT), and the annual change of consumer prices as 100 x InUCXFEJJCXFEH). You will then be ready to calculate the Taylor Rrule and to plot both the Taylor Rule and the Federal Funds rate in the same graph for your report. b) A brief discussion of the graph in (a). Point out the periods when the Fed's policy deviates from the Taylor Rule's prescription. c) What was the impact of the Fed's policy for much of the 19705 [relative to what the Taylor Rule suggested)? Why might the Fed have chosen this policy? Discuss briey and be sure to provide empirical evidence to support your arguments (i.e., use the data you have to illustrate your points). d) After 1985, how does the Fed's policy compare to the Taylor Rule prescriptions? What was the impact on output and inflation? Be sure to provide empirical evidence to support your argument (i.e., use the data you have to illustrate your points). e) In the early and mid-2000s, what was the stance of monetary policy relative to the Taylor Rule? What could be the potential consequences ofthis policy? Specifically, could this relate to the run up in housing prices in the early 20005 and their subsequent crash? How or why? f) After 2008, do you think the Fed could have implemented what the Taylor Rule prescribed? Why or why not? What can the Fed do to stimulate aggregate demand if the Taylor Rule rate is below zero? g) How does the current stance (i.e., 02 or (13 2021) of policy in the US compare to what the Taylor Rule predicts
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