The December 13, 2005, press release of the Federal Open Market Committee (FOMC) states that the FOMC "decided today to raise its target for the federal funds rate by 25 basis points to 41 ⁄4 percent." The press release also stated that "In a related action, the Board of Governors unanimously approved a 25-basis point increase in the discount rate to 51 ⁄4 percent."
a. Using a demand and supply graph for the federal funds market, show the equilibrium federal funds rate and the discount rate before the policy action of December 13, 2005, when the federal funds rate was 4% and the discount rate 5%.
b. Use your graph to explain how the Fed would raise the federal funds rate by 25 basis points (1 ⁄4%). Show in your graph the 25-basis-point increase in the discount rate. What policy action would the Fed use to bring about this increase in the target federal funds rate?