Question

Use the supply and demand analysis of the market for reserves to explain the following situations.

1. If a switch occurs from deposits into currency, what happens to the federal funds rate?
2. Why is it that a decrease in the discount rate does not normally lead to an increase in borrowed reserves?
3. What happens to the federal funds rate, borrowed reserves, and nonborrowed reserves, holding everything else constant.
   1. The economy is surprisingly strong, leading to an increase in the amount of checkable deposits.
   2. Banks expect an unusually large increase in withdrawals from checking deposit accounts in the future.
   3. The Fed raises the target federal funds rate.
   4. The Fed raises the interest rate on reserves above the current equilibrium federal funds rate.
   5. The Fed reduces reserve requirements.
   6. The Fed reduces reserve requirements and then offsets this action by conducting an open market sale of securities.

Answer 1

Q1 If people are demanding currency in hands then putting it in deposits then currency-deposit ratio (k) decreases

Federal funds rate means the interest rates at which commercial banks reserve balances to other banks over night on an UNCOLLATERAL basis

So due to less reserve surplus with banks ,they will lend less to other banks , thus federal funding rate will increase

Higher interest will decrease borrowing capacity of other commercial banks

Q 2 Decrease in discount rate does not normally leads to an increase in borrowed reserves because

1 commercials banks must be having surplus reserves so no need to borrow reserves even when discount rate decreases

2 economic situation like recession at which demand for loans by businesses and industries are less so banks don't need borrowed reserves

As demand for loans may be low due to economic situation

Q3

Q1 economy is strong leading to increase in amount of Checkable deposis-

Federal funds rates will decline as now more surplus reserves with banks to lend to other banks

Borrowed reserves less as banks have increase in their excess currency surplus or reserves due to increase in Checkable deposits

Non borrowed reserves will increase

Q 2 when large withdrawals on Checkable deposits

Federal funds rates will increase due to less reserves available to lend to other banks

Borrowed reserves will increase

Non borrowed will decrease

Q3 fed raises target federal funds rate it means it is adopting contractionary policy

Borrowed funds will decrease and non borrowed will increase

Q 4 if fed increases interest rates on reserves above current equilibrium federal funds rate then it means contractionary policy so borrowed funds will increase and non borrowed will decrease

Q5 fed reduces RR me and more reserves with banks

Which means more non borrowed funds and less borrowed funds

Q6 offsets by selling OMO

No changes in borrowed or non borrowed funds