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Unformatted text preview: . But the problem was not that the Fed failed to conform to the conventional
benchmark provided by the “Taylor rule,” as argued by Taylor (2009), but rather that it followed it too
faithfully, rather than taking account of the change in financial conditions. Michael Woodford 39 output
output near potential through cuts in the federal funds rate alone, owing to the
zero lower bound on nominal interest rates. Of course, the fact that reduced
aggregate demand resulted in lower economic activity and employment, rather
than simply in reductions in wages and prices to the extent needed to maintain
full employment, depended on the stickiness of wages and prices, as described in
standard textbook accounts. Implications for Monetary Policy
To what extent does this extension of the standard model imply changes to the
conventional conduct of monetary policy?
Taking Account of Financial Conditions
The model’s most obvious implication is that decisions about interest-rate policy
should take account of changes in financial conditions—in parti...
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