Show the impact in the Bank Reserve (Federal Funds) Market on graph, if the FOMC orders...

Show the impact in the Bank Reserve (Federal Funds) Market on graph, if the FOMC orders an open market sales (the Fed sells securities to commercial banks). (Label all axis and curves to obtain full credits)

Solutions

Expert Solution

FOMC orders an open market sales for decreasing the money supply in the market. Through an open market sale of securities, the FOMC is aiming to decrease the reserves of the commercial banks and thereby reducing the money supply in the market. This is a contractionary policy. It is from the bank reserves that the commercial banks creates credit. When the bank reserves are reduced the commercial banks will find it difficult to lend more money. This inturn will reduce the money supply in the market.

In the above figure the downward sloping DBR curve indicates the demand for the bank reserves. The vertical curves SBR₁ and SBR₂ indicates the supply of bank reserves. The point A is the initial equilibrium at which the quantity of reserves is R₁ at an interest rate of ir₁ . Now when there is a sale of securities to the commercial banks, the supply of bank reserves decrease and the supply curve will shift to the left. The new curve will be SBR₂ and the new equilibrium point will be B. The amount of reserves now will be R₂ .

Rahul Sunny answered 1 year ago

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