The following figure represents the money market in the United States, which is

Question

The following figure represents the money market in the United States, which is currently in equilibrium, as indicated by the grey star: INTEREST RATE (Percent 6.0 5.5 5.0 4.5 4.0 Money Supply Money mand 3.5 3.0 2.5 2.0 0.6 0.7 0.8 0.9 1.0 1.1 12 1.3 1.4 QUANTITY OF MONEY (Trillions of dollarsl Suppose the Federal Reserve announces that it is raising its target interest rate by 0.75% that is by 75 basis points The Federal Reserve could achieve this goal by: a. decreasing the money supply by $100 billion. b. decreasing the money supply by $300 billion C.increasing the money supply by $400 billion. d. increasing the money supply by $200 billion. O e, decreasing the money supply by $1 trillion.

Explanation / Answer

Option (b).

Current equilibrium is at intersection of money supply and money demand curves with interest rate 4% and quantity of money $1 Trillion (= $1,000 billion). When interest rate rises by 0.75%, new interest rate is 4.75% for which money demand will be $700 billion (From money demand curve). Equilibrium can be achieved if Fed decreases money supply by $300 billion (= $1,000 - $700 billion).

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