Graph the output gap and the inflation rate

Question

In this assignment, you will study the relationship between output and inflation. The data for the assignment can be found on Blackboard under “Course Documents/Assignments.” The file is named “Data-Assignment4.xlsx”. The data has an annual frequency and goes from 1955-2015.

You will be using the following variables:

• Pi - Inflation rate, (π_t)

• dPi - Change in the inflation rate, (π_t − π_t−1)

• Ygap - Output gap, ([Yt − Y ¯]/Y ¯)

• tPi - Deviation in the inflation rate from the target, (π_t − 2%)

• rFFR - Real Federal Funds Rate, (i_t − π_t)

1. The Phillips Curve:

(a) Graph the Output Gap and the Inflation rate. What is the correlation between the two series? Hint: Use “=correl()” in Excel to determine correlation.

(b) Graph the Output Gap and the change in the Inflation Rate. What is the correlation between the two series?

(c) Which series, the inflation rate or the change in the inflation rate, better relates to the Output Gap? Use your results above and economic analysis to discuss.

(d) Run a regression with dPi as the y-variable and Y gap as the x-variable. Report the coefficients, p-values, and R² Interpret the results.

2. Monetary Policy:

(a) Discuss the Taylor/Monetary-Policy Rule. Do you expect the policy coefficients to be positive or negative?

(b) Graph the real Federal Funds Rate and the Output Gap in a single graph. Discuss the relationship between the two variables.

(c) Graph the real Federal Funds Rate and the Inflation deviation in a single graph. Discuss the relationship between the two variables.

(d) Run a regression with rFFR as the y-variable, and Y gap & tPi as the x-variables. Report the coefficients, p-values, and R². Interpret the results. Does the Federal Reserve appear to care more about inflation or GDP?