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Unformatted text preview: 8 P OLICY P REVIEW FOCUS OF THE CHAPTER • This chapter provides a simple overview of policymaking at the central banks based on ‘Taylor Rule’. SECTION SUMMARIES 1. Media Level View of Practical Policy To understand the five basic elements of policymaking, we need to find out “who, what, why, when and how” of policy decisions. The ‘who’ of monetary policy in the US is the Federal Reserve, in short “the Fed”. They change the ‘what’ - the key interest rate to influence consumption and investment in the economy. Their goal, the ‘why’, is to keep inflation low and output stable around a trend path. The Fed has a 12 member committee, the Federal Reserve’s Open Market Committee (FOMC), which meets every six weeks (the ‘when’) to decide on whether to change the key interest rate. After the meeting, the Fed buys (or sells) Treasury Bills with money to lower (or increase) the interest rates. The buying and selling of Treasury Bills is the ‘how’ of monetary policy. 2. Policy as a Rule The Fed sets key interest rate, the Federal Funds Rate, according to the following rule, also called the Taylor Rule: - × +- + + = * * * * 100 ) ( t t t t t t Y Y Y r i β π π α π where * r is the equilibrium or natural rate of real interest consistent with natural rate of unemployment. Inflation is denoted by t π . The term * π π- t shows how high or low is the current inflation relative to its target level * π . This term 84 85 C HAPTER 8 shows how high are inflationary pressures in the economy. Finally, * * t t t Y Y Y- is the output gap term showing how much current output, t Y , deviates from the potential output level, * t Y , in percentages. These two terms serve as indicators of economic pressures that influence increase or decrease in the federal funds rate....
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- Spring '09
- The Land, inflation rate, Federal Reserve, federal funds rate