QUESTION 5 Suppose that the demand for federal funds curve is such that the quan
ID: 1096666 • Letter: Q
Question
QUESTION 5
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 3.5 percent.
Instructions: Enter your answer as a whole number.
a. Assuming no change in demand, will the Fed need to increase or decrease the supply of federal funds?
b. By how much will the quantity of federal funds have to change for the equilibrium to occur at the new target rate? Decrease by $ _______billion.?
Explanation / Answer
Since, a 1% increase in the rate causes a decline in the demand for funds by $120 million, so a rise in the rate from 3% to 3.5% would mean a $60 million decline in the quantity demanded of funds.
Since, the existing demand curve not change (does not shift), this is an upward movement along the demand curve. Thus, in order to bring back to equilibrium, the supply is decreased (leftward shift).