Suppose that the demand for federal funds curve is such that the quantity of fun

Question

Suppose that the demand for federal funds curve is such that the quantity of funds demanded changes by $120 billion for each 1 percent change in the federal funds interest rate. Also, assume that the current federal funds rate is at the 3 percent rate that is targeted by the Fed. Now suppose that the Fed retargets the rate to 1.5 percent. Assuming no change in demand, will the Fed need to increase or decrease the supply of federal funds? By how much will the quantity of federal funds have to change for the equilibrium to occur at the new target rate? by $ billion.

Explanation / Answer

ANSWER IS

Federal funds are excess reserves of a bank deposited to their regional reserve bank. This can be lent as a borrowing to other banks in case they have insufficient reserves. Federal funds rate is the interest rate charged by one bank to another to borrow fed funds overnight.

a) Low federal funds rate means expansion in monetary policy by the federal reserve. This makes the borrowing easy for the banks. This makes an increase in supply of federal funds as reduction in funds rate encourages commercial banks to take borrowings to meet reserve requirements.

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