Write a short essay about the recent history of the federal funds rate, its value as you write and its possible future. Use Taylor’s rule and include your answers to the following questions:
1. Interest rates cannot be less than zero. Does Taylor’s rule suggest that the best value for the federal funds rate would have been negative in recent years?
2. Is today’s federal funds rate too low, too high or abut right in view of Taylor’s rule?
For task 3, you need to assume value s for the inflation and unemployment rates for next 5-10 years . You can use the same values over that period of you may also think that there will be a trend (upward sloping for pessimistic and downward sloping for optimistic.) An alternative will be just assuming low inflation and low unemployment for the optimistic scenario its misleading!!!(INFLATION NOT GONNA GO LOW), and high inflation and unemployment for the pessimistic case.
3. Construct two scenario’s for US inflation and US unemployment, one optimistic and one pessimistic. Calculate the federal funds rate with Taylor’s rule according to your
scenarios. Now evaluate the market forecasts in figure 6.5 in the BIS report in the light of your scenarios.
Here, you just need to summarise and draw overall conclusions.
4. Do you see shortcomings or limitations of Taylor’s rule on the basis of your analysis?
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