Question

1.     For each of the scenarios below, explain the shift(s) in:

o   Demand

o   Supply

o   Federal Funds Rate (FFR)

o   Money Supply (MS)   

e.     The Fed reduces reserve requirements.

f.      The Fed conducts an open market sale.

g.     The Fed raises interest on reserves above the current equilibrium federal funds rate.

h.     The Fed reduces reserve requirements and sterilizes this by conducting an open market sale of securities. (The term “sterilize” means to leave the Federal Funds Rate (FFR) unchanged.

Answer 1

e) Decrease in reserve requirement increases the money supply in the economy because now, banks keep less reserves with themselves and lend the more money. It causes supply curve to shift rightwards.

f) Sale of government securities by the Fed decreases the supply of money in the economy. This shifts supply curve leftwards.

g) When the Fed raises interest on reserves then banks would prefer to reserve money with the Fed as a result, supply of money decreases. It shifts supply curve leftwards.

h) Decrease in reserve requirement increases money supply while sale of open market securities decreases money supply. So, money supply will be unchanged.