Initial Conditions

rr/D = .10

C = 500 billion

D = 1100 billion

ER = 0

a.) M = C + D If Rd = 300 - 40iff, given the information above, what is the market clearing federal funds rate? Assume that this is the target for the federal funds rate. Show all work. NOTE: To calculate the market clearing federal funds rate, you first need Rs. Rs is made up of required reserves and excess reserves. Here ER=0 so to find Rs, take the value for rr/D and multiply it by the value for D. Then you will be able to solve for the market clearing federal funds rate.

In the space on your sheet, draw a reserve market diagram depicting exactly what is going on here! Label the equilibrium point as point A.

b.) Suppose that due to whatever reason, reserve demand changes and you forecast the reserve demand to now be R_d = 260 - 40 i_ff. In order to keep the federal funds rate at target, what must the open market desk do? Be specific and show this development in your picture on your sheet (label the new equilibrium as point B).

c.) Suppose the alternative, that the open market desk does nothing different, that is, they hold the amount of reserves constant. What happens in the reserve market? What is the market clearing fed funds rate now? Label this development, that is, the new equilibrium as point C. Be sure to show all work.