Question

qp2

Suppose that in the federal funds market, iff and id are both 8% and ier is 2.5%.  Assume NBR are $1.2 trillion and Borrower Reserves are $0.1 trillion.  If the FR Bank lowers the discount rate, then the equilibrium rate for reserves will ____ and the amount of borrowed reserves will ____.

Answer is fall;rise

need help with solving with explanation.

Answer 1

iff is the overnight rate on loans of reserves i.e. banks with excess reserves can lend to those that are short
id is the rate on discount loans i.e when banks borrow from discount window

A lowering of discount rate allows banks to loan money from Fed at lower rates, thereby signalling the banks to further reduce their rates as if id<iff, there will be no borrowing. Therefore in equilibrium, the rates are lowered.

Like all other products, even reserves have a downward sloping demand function where rate is the price. Therefore just like any other product, if price decreases, quantity increases; here as the rate decreases, the amount of borrowed reserves increase.