1) In August 2011, the Fed's FOMC voted to decrease the federal funds rate target on several different occasions, reducing it to lower its target for the federal funds rate within the range between 0.25 basis points to 0% percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures. What action in the "open market" would the Fed's trader have had to take, other things equal, in order to induce this decrease in the federal funds rate? (you do not need to give a specific numerical answer).
2) Draw a supply-demand diagram of the Federal funds market which illustrates the effects of a massive treasury bill sale by the Fed in the open market.
3) If banks desire to increase their lending, but the Federal Reserve is not adding reserves to the banking system, what will happen to the level of short term interest rates? Explain your answer carefully.
4) "Sweep" accounts are combination checking/money market accounts which large banks currently offer to their corporate customers. These accounts sweep just enough funds out of the money market portion of the account to prevent checks written on the checking part of the account from bouncing. Suppose that banks suddenly made these accounts available to households. Draw a supply/demand diagram of the federal funds market to show the effect on the federal funds rate if the Fed did nothing. What action in the open market would the Fed have to take to maintain its existing interest rate target under these circumstances?
5a) Explain carefully why interest rates on each of the following short-term financial instruments will be closely tied to the level federal funds rate: short-term bank CDs, short-term Treasury bills, short-term commercial paper.
5b) Why is the yield on short-term Treasury bills usually less than the federal funds rate?
6) Suppose households and small firms withdrew funds from banks in response to rumors circulating that a computer virus would destroy banks customer account databases, or the recent events of financial meltdown in the Wall Street. What action would the Fed have to take in the open-market to maintain its existing fed funds target rate?