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Answer all of the following questions regarding the Money Supply and Reserves. Use the Market for...

  1. Answer all of the following questions regarding the Money Supply and Reserves.

    Use the Market for Reserves framework to analyze each of the following scenarios. Treat each scenario separately (i.e. draw a separate fully-labeled graph for each in order to get full credit). Assume that the market is initially in equilibrium. Important: Make sure that your graphs clearly show changes in the equilibrium federal funds rate, changes in the equilibrium level of reserves, and any shifts in the demand or supply curves. Explain in one sentence what your graph is showing.

    1. I. Commercial banks increase their demand for reserves.

2. II. The Fed buys Treasury bills to commercial banks.

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Answer #1

In following graphs, D0 and S0 are initial demand and supply curves for reserves, intersecting at point A with initial federal funds rate r0 and quantity of reserves Q0.

1.

When demand for reserves increases, demand curve shifts rightward, increasing Federal Funds rate and increasing quantity of reserves.

In following graph, increase in demand shifts D0 rightward to D1, intersecting S0 at point B with higher Federal Funds rate r1 and higher quantity of Reserves Q1.

2.

A Fed open market purchase of securities increases the supply of Reserves. Supply curve shifts rightward, decreasing Federal Funds rate and increasing quantity of Reserves.

In following graph, increase in supply shifts S0 rightward to S1, intersecting D0 at point B with lower Federal Funds rate r1 and higher quantity of Reserves Q1.

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