Question

Suppose banks incur heavy losses and become more cautious, increasing their demand for reserves. Explain and make use of a graph of the loanable funds market to show how the Fed can use open market operations to maintain the same federal funds rate

Answer 1

ANSWER:-

• Increment in demand after for saves moves the demand curve for saves rightward, expanding federal funds rate (FFR) and expanding amount of funds.
• To keep FFR unaltered, central bank conducts expansionary financial strategy, which builds cash gracefully by expanding saves by means of open market acquisition of protections. This moves the supply curve for holds rightward, diminishing federal funds rate (FFR) and expanding amount of funds.
• The net impact is FFR being unaltered at beginning level and an expansion in amount of funds.
• In following diagram, D0 and S0 are starting demand and supply curve for federal funds, crossing at point A with introductory federal funds rate (FFR) r0 and Amount of loanable funds A0.
• An increment in demand after movements D0 rightward to D1, converging S0 at point B with higher FFR r1 and higher amount of funds A1
• To counter this current, Fed's expansion in cash supply moves S0 rightward to S1, crossing D1 at point C with beginning FFR r0 and further higher amount of funds A2.

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