Answer to Question #252123 in Macroeconomics for Biba

Question

7. The Federal Reserve is scheduled to pay interest on bank reserves.
a. Suppose that the interest rate on reserves is 1 percentage point below market rates. Would banks still desire to minimize excess reserves? Would this affect the bank money equation in Summary point 8 above?
b. Suppose that the interest rate on reserves is equal to the market rate. How would your answer to achange?
c. Using your answer to b, can you see why the relationship between reserves and bank money becomes very loose when market interest rates are
zero (the à ƒ ƒ ¢ € œliquidity trapà ƒ ƒ ¢ € )?

Answer 1

a) The banks will desire to minimize excess reserves since the interest will be below the expected value. Therefore, this will lower the outcome needed in maintaining the bank's standards.

b) in this case, there will be stability within the financial institution, which will be beneficial in maintaining the outcome.

c)Reserves act as the additional capital to financial institution. Therefore, when they go below the market rate, it makes the bank to lose its market value.