Macro - Lecture 3 (Monetary Policy II)

Question 1

What is the Taylor Rule?

Answer 1

A formula guiding interest rate decisions based on inflation and output gaps.

Question 2

What is the formula for the Taylor Rule?

Answer 2

iₜ = r + πₜ + 0.5(πₜ − π) + 0.5(yₜ − ȳ)

iₜ: Nominal interest rate (central bank policy rate)
r: Real equilibrium interest rate (natural rate of interest, typically ~2%)
πₜ: Current inflation rate
π: Target inflation rate (e.g., 2%)
yₜ: Actual output (GDP)
ȳ: Potential output (GDP at full employment)
yₜ − ȳ: Output gap (percentage deviation of actual output from potential output)

Question 3

What is the Zero Lower Bound (ZLB)?

Answer 3

A situation where nominal interest rates cannot go below zero, limiting traditional monetary policy.

Question 4

What is a solution to the Zero Lower Bound problem?

Answer 4

Implementing unconventional policies like QE or using fiscal policy.

Question 5

How does QE lower interest rates?

Answer 5

By increasing bond prices, which reduces yields and lowers long-term interest rates.