If the current market federal funds rate equals the target rate and the demand for reserves decreases, the likely response in the federal funds market will be:

Question

Quizplus · Accepted Answer

If the demand for reserves decreases, there will be an excess supply of reserves in the market, and banks will have more extra reserves than they need to meet their requirements. This will lead to a decrease in the market federal funds rate, as banks will lend out their excess reserves to other banks at lower rates to avoid earning zero interest on them. As a result, the market federal funds rate will fall below the target rate. The Fed can respond to this by conducting open market sales to reduce the supply of reserves and push the market rate back up to the target rate.

If the Current Market Federal Funds Rate Equals the Target