202 Assignment Solution: Chair the Fed

Solution

1. According to the theory of monetary policy, a higher Federal Funds Rate should slow the economy down, lowering inflation and raising unemployment.
2. If the unemployment rate is above the natural rate, and the inflation rate is below target, lower the FFR. Note that there may be conflicts between what happens to inflation and what happens to unemployment for a given FFR change.
3. Confirm that the student played the game at least once through 16 quarters and reported the FFR, inflation and unemployment rate in each period.
4. Confirm that their conclusions about how well their policy choices worked is reasonable.
5. Conclusions about the game could include that there is inertia in the model causing lags in response of inflation and unemployment; that inflation and unemployment don’t respond at the same rate to changes in FFR; that it’s difficult to be successful in managing this economy.
6. Real world monetary policy is difficult!