Economics 601

Workshop #2 Answer Key

Dustin Chambers

Fall 2014

Instructions: Please show all of your work. Turn-in one assignment per group,
and make sure to list the names of each student in your group. Tip: This
assignment can be solved very quickly using Microsoft Excel.
1.

Suppose that the potential growth threshold for the U.S. is 2.5% per
year. If the Obama Administration wants to reduce the unemployment
rate by a full percentage point (i.e. 1%-point) over the next year, what
is the required rate of economic growth in the United States?
According to Okuns Law:
0.4% !"# !"#$%#&'( =
0.4% !"# 2.5% = 1%
!"# = 5%

2.

Suppose that you work for the Federal Reserve Bank and are asked to
determine the Federal Funds rate target using the Taylor Rule:

Nominal Fed Funds Rate Target = + 2.0 + 0.5 ( 2.0 ) 0.5(GDP Gap)
Use the following data to 1) calculate the Federal Funds target rate
based on the Taylor Rule, and 2) plot the Taylor Rule rate the actual
Federal Funds rate together and comment on any
similarities/differences.
Year
2000
2000
2000
2000
2001
2001
2001
2001
2002
2002
2002
2002
2003
2003
2003
2003
2004
2004
2004
2004
2005
2005
2005
2005
2006
2006
2006
2006
2007
2007
2007
2007

Quarter
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4

inflation GDP GAP Taylor Rule fed funds rate

3.24
-2.93
7.33
5.68
3.33
-3.13
7.56
6.27
3.51
-3.00
7.77
6.52
3.43
-3.20
7.75
6.47
3.40
-2.53
7.37
5.59
3.38
-2.20
7.17
4.33
2.70
-1.33
5.72
3.50
1.86
0.00
3.79
2.13
1.25
0.40
2.68
1.73
1.30
0.67
2.62
1.75
1.59
0.47
3.15
1.74
2.20
0.73
3.94
1.44
2.87
0.73
4.94
1.25
2.13
1.27
3.56
1.25
2.20
1.27
3.67
1.02
1.90
0.67
3.52
1.00
1.79
0.40
3.49
1.00
2.87
0.20
5.21
1.01
2.73
-0.13
5.16
1.43
3.32
-0.13
6.05
1.95
3.04
-0.47
5.80
2.47
2.95
-0.87
5.86
2.94
3.83
-1.00
7.25
3.46
3.74
-1.13
7.18
3.98
3.65
-1.60
7.28
4.46
4.01
-1.67
7.85
4.91
3.34
-1.73
6.88
5.25
1.94
-2.13
4.98
5.25
2.42
-2.00
5.63
5.26
2.65
-1.93
5.94
5.25
2.36
-1.60
5.34
5.07
3.97
-1.33
7.62
4.50

Federal Funds Rate (%)

Taylor Rule

6
5
4
3
2
1

Actual Fed Funds Rate

0
2000 2001 2002 2003 2004 2005 2006 2007

3.

The original Federal Reserve Act (1913) has been amended on

numerous occasions as the role of the Federal Reserve has evolved.
Until 2010, the Fed had a two-pronged mandate, with each mandate
created by one of the following bills:

The Employment Act (1946)

Full Employment and Balanced Growth Act (1978)

a.) What was the Feds two-part mandate prior to 2010? Match each
mandate with the bill that created it above. Why did Congress make
these changes (i.e. provide some historical background/insights to
rationalize their policy decisions).
Prior to 2010, the Feds two mandates were to maintain full
employment (created by The Employment Act (1946)) and price
stability (Full Employment and Balanced Growth Act (1978)).
Congress mandated the first change (full-employment) as the U.S. was
exiting the Great Depression and unemployment was the paramount
concern of policy makers. The added mandate of maintaining price
stability was a reaction to the record-breaking two-digit inflation that the
U.S. experienced during the 1970s (i.e. The Great Inflation).
b.) The DoddFrank Wall Street Reform and Consumer Protection Act
(2010) added one additional mandate to the Federal Reserve. What is
that mandate? What are some advantages and disadvantages of this
policy change?
The Dodd-Frank bill added the mandate of maintaining financial
stability. The advantage, if the bill can succeed in promoting its goals,
is to prevent major financial crises like that of 2008 and increase the
publics faith in the financial system. Critics of the bill cite numerous
problems, including 1) the greater politicizing of Fed actions, which
threatens Fed independence, 2) a lack of policy tools with which to
prevent crises, and 3) the failure of the bill to end the very government
policies which helped foster the housing bubble (mortgage guarantees
vis--vis Fannie Mae and Freddie Mac).