b) Now let's pretend that the Fed had acquired the tools of the discount rate and interest rate on reserves and use them to try to limit the fluctuations in the federal funds rate. In particular, they set the discount rate at 7.5% and the rate they pay on reserves at 6.5%. Draw a new reserve diagram and show and explain why points A and B would not occur in this new ('pretend') regime. Be sure to explain why the funds rate would never rise as it did at point A and it would never fall as it did at point B. Label the new market clearing points as points A' and B' respectively. (5 points for correct and completely labeled diagram)1) (20 points) Suppose reserve demand is given by: Ra = 450 - 50 ixx and Reserve supply is given by: Rs = 300 a) Solve for the equilibrium federal funds rate. Draw a reserve market diagram below labeling this initial equilibrium as point A. (10 points for correct and completely labeled diagram) b) Suppose that the Fed decides that the economy needs a little boost and thus decides to lower the federal funds rate target by 50 basis points (.5 %). Explain exactly how this change in policy would be implemented. c) Now solve for the new reserve supply associated with this new target, assuming | that reserve demand is constant (stable) and label on your diagram as point B. 2) a) We go back in time to the very end of 1990 where the US economy was officially in a recession. Use the diagram below and the information in the diagram to draw a reserve market diagram mapping points A and B from the time series (FRED) diagram to your reserve market diagram (point A, 12/26/90, point B 12/31/90). Assume, as we did in the lecture, that the source of this deviation from target was reserve demand being different than the Fed's forecast of reserve demand. (10 points for correct and completely labeled diagram) FRED - Effective Federal Funds Rate - Federal Funds Target Rate (DISCONTINUED SERIES) 9.0 8.5 FF : 890 8.0 E 7.5 7.0 6.5 FF TARGET Pant B 6.0 = 7% FF =5.5% 5.5 1990-12-22 1990-12-26 1990-12-30 1991-01-01 Shaded areas indicate US recessions - 2014 research sthowisfed.org