Refer to the figure above. If the Federal funds market is at equilibrium at point C and the Federal Reserve decides to conduct an open-market sale, then it must be trying to set a:
A) Higher target federal funds rate by increasing the amount of reserves in the market
B) Higher target federal funds rate by reducing the amount of reserves in the market
C) Lower target federal funds rate by increasing the amount of reserves in the market
D) Lower target federal funds rate by reducing the amount of reserves in the market

Question

Refer to the figure above. If the Federal funds market is at equilibrium at point C and the Federal Reserve decides to conduct an open-market sale, then it must be trying to set a:
A) Higher target federal funds rate by increasing the amount of reserves in the market 
B) Higher target federal funds rate by reducing the amount of reserves in the market 
C) Lower target federal funds rate by increasing the amount of reserves in the market 
D) Lower target federal funds rate by reducing the amount of reserves in the market

Quizplus · Accepted Answer

An open-market sale by the Federal Reserve reduces the amount of reserves in the Federal funds market, shifting the supply curve to the left (from S to S') and increasing the federal funds rate. This indicates that the Federal Reserve is trying to set a higher target federal funds rate. Therefore, the correct answer is B, which states that the Federal Reserve is trying to set a higher target federal funds rate by reducing the amount of reserves in the market.

Refer to the Figure Above