Question

22. Using the supply and demand analysis of the market for reserves, indicate what happens to the federal funds rate, borrowed reserves, and nonborrowed reserves, holding everything else constant, under the following situations:

d) The Fed raises the interest rate on reserves above the current equilibrium federal funds rate.

e) The Fed reduces reserve requirements.

f) The Fed reduces reserve requirements and then offsets this action by conducting an open market sale of securities.

Answer 1

a) If the fed decides to raise the interest rate above the current quilibrium i.e when they increase the rate from g to g', the horizontal part of the demand shifts up from RO to RO'. Other than that, the NBR or the non borrowed reserves and borrowed reserves stay the same

b) If the bank reduces the reserve requirement, the banks have to borrow less now and thus rate falls down from g' to g. The demand also falls down.The NBR and borrowed funds however stay the same

c) When the reserve requirements are reduced and an open market sale of securities are conducted, the NBR reduces to NBR'. The funds rate may also decrease but it largely depends on if reduction is greater in magnitude compared to the offset mentioned in the question.