Consider a recently founded economy, Del Griffith Park, whose politicians are debating economic policies to implement. They are first considering whether or not to found a central bank and issue their own currency. Right now, they use US dollars for all their transactions and thus are subject to monetary policy dictated by the Federal Reserve. Banks in this economy like to hold reserves when interest rates are low, and dislike holding reserves when interest rates are high, and can borrow and lend with US banks at the US Federal Funds Rate.

Question 1- Draw the supply and demand curves in the market for reserves. Be sure to label the axes correctly! Then explain why each curve has the shape that it does, i.e., why the demand curve is downward sloping, etc.

Question 2-Suppose the Federal Reserve decides that after years of low-interest rates, they would like to increase the federal funds rate. What is the effect on the Del Griffith Park government?