Question

1. As a junior bond trader at Goldman Sachs, you have been asked by your boss to explain the Taylor Rule and how it can be a helpful guide to how the FED sets monetary policy. Write a short report summarizing your findings. Your report should contain the following pieces of information: a. Turn in a well labeled and professional looking plot of the Taylor Rule and the federal funds rate on a quarterly basis from 1970Q1 to 2018Q:3. To perform this task, download following data from FRED: real GDP (GDPC1), real potential GDP (GDPPOT); core consumer prices (JCXFE): and the federal funds rate (FEDFUNDS) Calculate the output gap as 100 × ln(GDPCI/GDPPOT). Calculate the annual change of consumer prices as 100 × ln(JCXFE/JCXFEt-4). Note that the federal funds rate data must be converted from a monthly series to a quarterly series. Use the tools on FRED to do so by changing the "Frequency" to quarterly from monthly, and by selecting the aggregation method "average." Plot both the Taylor Rule and the federal funds rate in the same graph, and submit in your report. [You will probably find it easier to download the data from FRED and then create and plot the Taylor Rule and the federal funds rate in Excel.] In your report, provide a brief discussion of this plot with special emphasis on time periods when there are deviations between the FED's policy and the Taylor rule's prescription.