Question

Suppose the FOMC has decided the target federal funds rate to be 1%. If due to an increase in seasonal demand for loans, the effective Federal Funds rate is 1.25%. What kind of open market operations will the New York federal reserve conduct?

a) Open market purchases or sales?

b. Dynamaic or defensive operations?

Answer 1

a) The current interest rate is below the target rate and so what is needed is an increase in the money supply level. For this to happen we need an open market purchase that we buy away bonds from the economy and hence increase the money supply level thus reducing the interest rates. An open market purchase is thus needed here.

b) The operations needed here will be defensive operations as it is one time, the idea is to push back the interest rates to the 1% level because of a seasonal demand for loans. Thus what is needed is a one time strategy here not a dynamic one.