7.0% 6.5% 5.5% 95.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% $0 $10 520 530 540 550 560 570 580 590 $100 $110

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7 0 6 5 5 5 95 0 4 5 4 0 3 5 3 0 2 5 2 0 1 5 1 0 0 5 0 0 0 10 520 530 540 550 560 570 580 590 100 110 1 (63.87 KiB) Viewed 17 times

7.0% 6.5% 5.5% 95.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% $0 $10 520 530 540 550 560 570 580 590 $100 $110 $120 $130 $140 $150 $160 Bank Excess Reserves ($Billion) The model of the federal funds market that we have leamed is sometimes called the corridor model. This is because, in this model the equilibrium fed funds rate fluctuates between the discount rate and the interest on reserves. This gives the Fed a tool to control the fluctuations in the equilibrium fed funds rate. Let's see how. Assume that the supply of federal funds equals $70 billion. Suppose that currently the discount rate is 4.5 percent and the interest on reserves equals 1.5 percent. In this case, if demand for reserves increases by $40 billion dollars, the equilibrium fed funds rate will increase to percent, and if it decreases by $40 billion, the equilibrium fed funds rate will decrease to percent. Now suppose the Fed wants to reduce the fluctuations in the equilibrium fed funds rate. So it changes the discount rate to 3.5 percent and the interest on reserves to 2.5 percent. In that case, if demand for reserves increases by $40 billion dollars, the equilibrium fed funds rate will increase to percent, and if it decreases by $40 billion, the equilibrium fed funds rate will decrease to percent. Federal Funds Rate