M&B3 3rd Edition by Dean Croushore

Exercise 4

Suppose that the Fed's Open-Market Desk thinks that the demand for reserves when the federal funds rate exceeds the interest rate on reserves is given by

where i is the federal funds rate in percent and D is expressed in billions of dollars. Suppose that the Fed is currently supplying $29 billion in nonborrowed reserves. Discount loans for business needs are $1 billion. The primary credit discount rate is currently set at 4 percent and the interest rate on reserves is 2 percent. If the Fed's target for the federal funds rate is 3.5 percent, does the Desk need to change the supply of reserves in the market How much does it need to add or withdraw from the market After carrying out its daily actions, what will be the equilibrium amount of reserves and discount loans