1) In this question we are going back in time and compare the implied federal funds rate from the original Taylor rule vs the Mankiw rule. The time period we are investigating is the third quarter of 2008. For the quarterly data on GDP and potential GDP, the date notation for the third quarter of 2008 is '2008-07-01.' Use the following links to calculate the GDP gap during this time.
Data on real GDP
https://research.stlouisfed.org/fred2/series/GDPC1
Data on (real) potential GDP
https://research.stlouisfed.org/fred2/series/GDPPOT
To calculate the 'inflation gap in the Taylor rule, you need to use the link below and take the percent change in the PCE overall index from the third quarter of 2007 (2007-07-01) to the third quarter of 2008 (2008-07-01). We assume, as Taylor did, that the target rate of inflation = 2%.
Quarterly data on the PCE price index
https://research.stlouisfed.org/fred2/series/PCECTPI
a) Using the data links above, calculate the federal funds rate implied by the original Taylor rule. We assume that the equilibrium (natural) real rate of interest is 2%, just like Taylor did, and we use the same coefficients as Taylor did. (please show all work).
b) Using the link below for the federal funds target, compare your answer in part a) to what the actual target was as of September 30, 2008 (note the data on the FF target are daily so use the data from 2008-09-30). Was the Fed acting hawkish or dovish relative to the federal funds rate implied by the Taylor rule? Explain.
Daily data use for the target of the federal funds rate
https://research.stlouisfed.org/fred2/series/DFEDTAR
We now move on to the Mankiw rule. To calculate the funds rate implied by the Mankiw rule, we need different data: the PCE CORE rate of inflation and the unemployment rate at the same time period.
Quarterly data on the PCE CORE price index
https://research.stlouisfed.org/fred2/series/JCXFE
Unemployment rate (the data are monthly so use data for September 2008 as in 2008-09-01).
https://research.stlouisfed.org/fred2/series/UNRATE
c) Using the links above, calculate federal funds rate implied by the Mankiw rule. Again, please show all work.
d) Now compare the funds rate implied by the Mankiw rule to the target for the federal funds rate..... was the Fed acting dovish or hawkish? Explain.
e) Now compare the two rates implied by each rule and explain why one of the rules does a MUCH better job at explaining Fed behavior (tuning in the Fed) than the other rule.