Federal funds

An article in the Wall Street Journal discussed the views of

John Williams, the president of the Federal Reserve Bank

of San Francisco, about the Taylor rule. According to the

article, Williams argued that if the Fed had attempted to

follow the Taylor rule during the recession of 2007–2009,

it would have had to do “something not easily done, and

that would have been for the Fed to have pushed short-term

rates deeply into negative territory.”

a. What does it mean for an interest rate to be negative?

b. Use the equation for the Taylor rule to show how

the federal funds rate target might be negative.

Assume that the equilibrium real federal funds rate

and the target rate of inflation are both 2 percent

and the current inflation rate is 0 percent.

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