Chapter 31, Problem 2CYU

To determine

The action that Fed will take to ensure that the federal fund rate will remain unchanged.

Explanation of Solution

Federal reserves will purchase T-bills from open market operations so that interest rates can be brought down. As per the action taken by the Fed, the increased interest rates will be lowered as the money supply will be increased due to the purchase of T-bills. This will reduce the interest rate and it will lead to the previous equilibrium position.

  

In this graph, E represents the equilibrium. If the interest rate is increased then E2 equilibrium will be obtained. To ensure that the interest rate remains R1, then Fed will purchase T-bills by which the money supply can be increased this will help in attaining E3 equilibrium where the interest rate will be R1.

Economics Concept Introduction

Federal Reserve System: It is a central bank that looks after the banking system of the country along with the control of its monetary base. The monetary base is the sum of circulating currency and the reserves in the bank.