Question

pq 1

In the market for reserves, when iff < id and iff > ier, an open market ____ shifts the supply curve to the _____ and causes the federal funds interest rate to fall.

Please help with explanation of relationship. answer is : purchase; right

Answer 1

When Federal Banks makes Open market purchases, they are buying Bonds from the member banks. As a result, the member Banks have more money to lend to the public. This increases the Money Supply in the economy. Therefore increase in Money supply leads to fall in interest rates( cost of borrowing ) . When the cost of borrowing decreases, more people avail loans and therefore the Private investment expenditure increases and  consumption increases, causing increase in overall Aggregate Demand.

The relationship between Money Supply and Interest rates is that, as the Money Supply increases( shifts rightwards ), the interest rate decreases( R2), whereas if the money supply falls( shifts leftwards) the interest rate increases(R1). Show in below figure.

Answer : Purchase ; righwards