Question

1. The Fed kept the Federal Funds rate target unchanged at 5.25% from June 2006 to September 2007. However, the effective Federal Funds rate dropped from 5.41% on August 9th 2007 to 4.54% on August 14th 2007. If the Fed did not take any monetary measures from August 9th 2007 to August 14th 2007, graphically show what could have caused the decrease in the Federal Funds rate. If you were the Fed’s chairman, what measures would you take to achieve the 5.25% target. Use the diagram of the reserve market to support your answer.

Answer 1

The decrease in the Fed fund reserve has an inverse relation with the fed fund rate. when there is a decrease in the fed fund rate from the market rate and touch lower then the targeted rate (if the market rate is higher than the targeted rate) in that case the quantity of reserve will increase. there may not be always the reason for monetary measures taken by the government. it may be due to the excess flow of money from the public to the bank in the form of saving or fixed deposit, which leads to an excess supply of money and lower the interest rate. to resolve this problem government can take monetary measures to bring up the Fed rate by selling bonds. in that way, the fed reserve will come down and it will push the fed rate up to the target rate.