Suppose the Fed's Open-Market Desk Thinks the Downward-Sloping Portion of the Demand

question 4

Essay

Suppose the Fed's Open-Market Desk thinks the downward-sloping portion of the demand for reserves is given by the equation
D = 28 ? (3 × i),
where i is the federal funds rate in percent and D is expressed in billions of dollars.Suppose the Fed is currently supplying $26.5 billion in nonborrowed reserves.There are no secondary or seasonal credit discount loans.The primary credit discount rate is currently set at 2 percent and the interest rate on reserves is 0.30 percent.The Fed's target for the federal funds rate is 1 percent.

a.Does the Desk need to change the supply of reserves in the market? How much does it need to add or withdraw from the market? After carrying out its daily actions, what will be the
equilibrium amount of reserves and discount loans?

b.Suppose the demand curve for reserves shifts to
D = 35 ? (3 × i).
The Fed does not realize that the demand curve has shifted, so it keeps the supply of nonborrowed reserves at the level you determined in part a. Calculate the equilibrium federal funds rate, reserves, and the amount of primary credit discount loans.

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