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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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