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The Market for Reserves

The Market for Reserves. Demand for Reserves. When the federal funds rate is high, the opportunity cost of holding excess reserves is also high. Banks demand fewer excess reserves. When the federal funds rate is low, the opportunity cost of holding excess reserves

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The Market for Reserves

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  1. The Market for Reserves

  2. Demand for Reserves When the federal funds rate is high, the opportunity cost of holding excess reserves is also high. Banks demand fewer excess reserves. When the federal funds rate is low, the opportunity cost of holding excess reserves is also low. Banks demand more excess reserves. ffr ff2 ff1 Demand 0 Reserves Q1 Q2

  3. Supply of Reserves ffr Supply When the federal funds rate is high, banks borrow more from the Fed, causing reserves to rise. When the federal funds rate is low, banks borrow less from the Fed, causing reserves to fall. ff2 ff1 0 Q1 Q2 Reserves

  4. Market Equilibrium ffr Supply Market equilibrium occurs where the demand for reserves equals the supply of reserves. ffeq Demand 0 Qeq Reserves

  5. Expansionary Open Market Operations ffr S1 S2 Expansionary open market operations increase the amount of reserves supplied to the banking system. The supply curve shifts to the right. The federal funds rate falls. ff1 ff2 D 0 Q1 Q2 Reserves

  6. Contractionary Open Market Operations ffr S2 S1 Contractionary open market operations decrease the amount of reserves supplied to the banking system. The supply curve shifts to the left. The federal funds rate rises. ff2 ff1 D 0 Q2 Q1 Reserves

  7. Expansionary Discount Lending ffr S1 S2 Expansionary discount lending increases the amount of reserves supplied to the banking system. The supply curve shifts to the right. The federal funds rate falls. ff1 ff2 D 0 Q1 Q2 Reserves

  8. Contractionary Discount Lending ffr S2 S1 Contractionary discount lending decreases the amount of reserves supplied to the banking system. The supply curve shifts to the left. The federal funds rate rises. ff2 ff1 D 0 Q2 Q1 Reserves

  9. Increase in Reserve Requirements ffr When reserve requirements increase, banks must hold more reserves. The demand for reserves rises. The federal funds rate increases. S ff2 ff1 D2 D1 0 Q1 Q2 Reserves

  10. Decrease in Reserve Requirements ffr When reserve requirements decrease, banks may hold fewer reserves. The demand for reserves falls. The federal funds rate decreases. S ff1 ff2 D1 D2 0 Q2 Q1 Reserves

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