Use graphs of the federal funds market to analyze each of the following three situations. Be 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 and supply curves. Assume that you are analyzing a situation in which reserves are scarce.
a. Suppose that the Fed decides to increase its target for the federal funds rate from 2% to 2.25% while also increasing the discount rate from 2.5% to 2.75%. Show how the Fed can use open market operations to bring about a higher equilibrium federal funds rate.
b. Suppose that banks increase their demand for reserves. Show how the Fed can offset this change through open market operations in order to keep the equilibrium federal funds rate unchanged.
c. Suppose that the Fed decides to decrease the required reserve ratio but does not want the decrease to affect its target for the federal funds rate. Show how the Fed can use open market operations to accomplish this policy.