Open Market Operation
Suppose the federal funds market is described by the following equations:
Q d = 100 - 100i ff
Q s = 95
Where Qd denoted the quantity of reserves demanded, as function of the federal funds rate if f ; and Qs denotes the quantity of reserves supplied. NOTE: to start with, lets assume that the Fed does not pay any interest rate on reserves held by private banks at the Fed): ier = 0: Answer to the following
1. Draw a graph displaying both supply and demand, and identify the equilibrium point.
2. Using the specific functional forms, compute the equilibrium values for the federal funds rate and the amount of reserves.
3. How would the graph in 1. and the answer in 2. change if suddenly the Fed decided to pay ier = 0:01 (1%)
4. Now, suppose the Fed would like to lower the equilibrium federal funds rate to 2%. By how much should the Fed increase the supply of reserves? What happens graphically?
5. By how much should the Fed further increase reserves to cut the federal funds rate to 0.5%? Explain.