Please show all steps/work, Thanks! Suppose that the demand for federal funds cu

Question

Please show all steps/work, Thanks!

Suppose that the demand for federal funds curve is such that the quantity of funds demanded changes by $120 billion for each 1 precent change in federal funds interest rate. Also, assume that the current Federal funds rate is at the 3 precent rate that is targeted by the Fed. Now suppose that the Fed retargets the rate to 3.5 precent. 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 new target rate?

Explanation / Answer

The Fed will have to decrease the supply of federal funds to get the rate to go up. Since there is a 120 billion decrease in demand for each one point increase in the federal funds rate (since the demand curve slopes downward) to get the rate up 0.5 point the Fed will have to reduce supply by 120/2= 60 billion.

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