During the financial crisis, the Federal Reserve developed
a number of new policy tools and allowed
the monetary base to triple. However, the Fed
never indicated that it was willing to allow the inflation
rate to rise above its inflation target of 2%.
a. What would be the effect on the output gap
and the inflation rate of the Fed’s indicating it
is willing to increase its target inflation rate?
b. Charles Evans, president of the Federal Reserve
Bank of Chicago, gave a speech in January
2012 in which he argued that the Fed should
pursue an expansionary monetary policy until
the unemployment rate fell below 7% or the
inflation rate rose above 3%. Do you think that
this policy would be more effective than actual
Fed policy in stimulating the economy? Explain.