Everything else constant, in the reserves market, if the supply of federal funds intersects the reserve demand curve on the flat section, an open market purchase

Question

BlackTom AI · Accepted Answer

When the supply of reserves intersects the reserve demand curve on its flat (horizontal) portion, the federal funds rate is pinned at the administered floor (for example, the interest on excess reserves), so an open market purchase does not change that rate.

1) Relevant knowledge points and concepts
- Reserve demand curve: banks’ demand for reserves can include a horizontal segment where the federal funds rate is equal to an administered rate (a “floor”) because banks are indifferent to trading funds at that rate.
- Reserve supply: open market purchases increase the supply of reserves (shift the supply curve right).
- Price determination: when demand is perfectly elastic (horizontal) at a given rate, changes in supply change quantity but not price.

2) Step-by-step reasoning
Step 1: Identify the starting equilibrium: supply S0 intersects demand D at the flat segment; the federal funds rate equals the flat rate r*.
Step 2: An open market purchase by the central bank increases reserves; supply shifts right from S0 to S1.
Step 3: With the demand curve horizontal at r*, the new intersection is at the same rate r* but at a larger quantity of reserves.
Step 4: Therefore the federal funds rate remains unchanged despite the higher quantity of reserves.

3) Intermediate (illustrative) steps/numbers
- Suppose the horizontal segment is r* = 1.00%. Initial quantity Q0 determined by intersection of S0 and D. After purchase, supply becomes S1 = S0 + ΔS, and intersection with D still occurs at r* = 1.00%, now at Q1 = Q0 + ΔS.

4) Why the correct answer is correct
Because a horizontal demand implies perfectly elastic demand at that rate: any increase in supply shifts the intersection rightward along that horizontal segment without changing the rate. The administered rate (floor) anchors the federal funds rate.

5) Why other options are incorrect
- "Increases the federal funds rate.": Wrong — increasing supply cannot raise the price when demand is flat; at most it could lower the rate if demand were downward-sloping, but not increase it.
- "Lowers the federal funds rate.": Wrong in this case — when intersection is on the flat section, the rate is fixed, so more supply does not lower it.
- "Has an indeterminate effect on the federal funds rate.": Wrong — the effect is determinate: no change, because the horizontal demand pins the rate.

6) Conclusion
Therefore, an open market purchase does not affect the federal funds rate, confirming the provided correct answer: "does not affect the federal funds rate."

Everything else constant, in the reserves market, if the supply of federal funds intersects the reserve demand curve on the flat section, an open market purchase 单项选择题

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Everything else constant, in the reserves market, if the supply of federal funds intersects the reserve demand curve on the flat section, an open market purchase 单项选择题

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