Question

Using the supply and demand for reserves graphs, show how the following events affects the federal fund rate, monetary base, non-borrowed reserves, borrowed reserves, the money multiplier, and the money supply.

Assume the federal fund rate is equal to the discount rate. The Fed performs an open market sale.

Answer 1

Fed has the complete control over the monetary base. The monetary base reduced through the wear out of currency. This monetary base control through given paper currency policy between currency ad reserves. The demand for monetary base comes from the demand for paper currency and demand for reserves. Smaller quantity of monetary base raises the value of dollar. Fed influence the monetary base through loans and open market operations.
If the federal funds increase there is higher opportunity of holding the reserves. The demand curve for reserves is downward sloping. With increase in the interest rate will improve the rate of non borrowed reserves and reduce the borrowed reserves. This will attract the unborrowed reserves and attract new participants to the market, and increase the demand. This will change with respect to the liquidity requirements.
Fed influence the money multiplier through the reserve requirements. If the reserve ratio is high, there is low level of amount for allocation of loans. This will affect the demand among the consumer’s towards this. The lowering of money multiplier also happened. The discount loans are mainly depends on borrowing and repaying behaviour of the bank. For the policy implementation open market operations are preferably used because it is more precise and immediate control of the central bank.