Economics 470/570
Winter 2014
Practice Problem Set 3
1. (a) Explain why the demand curve for reserves slopes downward. (b) Explain the shape of the supply curve for reserves.
2. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, (c) an increase in required reserves, and (d) a change in the interest rate paid on reserves.
3. Describe the three traditional tools available to the Fed for controlling the money supply. What tool has the Fed added to its aresenal recently, and why is this important?
4. What is meant by the phrase lender of last resort? Why is this important? Explain and show graphically how the Fed uses discount rate policy to act as a lender of last resort and how this limits the amount the federal funds rate can rise.
