Effect of an increase in risk aversion on money market and assessing the Fed's policy.
Suppose there is an increase in risk aversion by wealth holders in the sense that, other things equal, they want to hold more of their wealth in money (bank deposits) and less in securities.
With the help of a graph of the money market, explain the effect on the interest rate and the quantity of money.
Assume the policy of the Fed is to use open marketplace operations to return the quantity of money to its original equilibrium level. Explain what the Fed would do and illustrate your answer graphically.
Evaluate this policy of the Fed: Is it desirable or undesirable?