Question

The following statements come from a Federal Reserve press release dated June 14, 2017: · The Board of Governors of the Federal Reserve System voted unanimously to raise the interest rate paid on required and excess reserve balances to 1.25%, effective June 15, 2017. · The Board of Governors of the Federal Reserve System voted unanimously to approve a 1/4 percentage point increase in the primary credit rate to 1.75%, effective June 15, 2017.

Demonstrate your answer with a graph of the loanable funds market and AD/AS

Answer 1

Increase in primary credit rate will decrease investment and consumption spending, lowering aggregate demand. The AD curve will shift leftward, decreasing both price level and real GDP. In the loanable funds market, fall in investment spending will decrease the demand for loanable funds, shifting the demand curve leftward, lowering both market interest rate and quantity of loanable funds.

In following graphs, in the AD-AS diagram, AD0 & SRAS0 are initial aggregate demand and short-run aggregate supply curves intersecting at point A with initial price level P0 and real GDP Y0. As AD falls, the AD curve shifts left to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1. In the loanable funds market, D0 & S0 are initial demand and supply curves of loanable funds, intersecting at point A with initial interest rate r0 and quantity of loanable funds Q0. As demand for loanable funds falls, D0 shifts left to D1, intersecting S0 at point B with lower interest rate r1 and lower quantity Q1.