Question

Imagine working at the Trading Desk at the New York Fed. Explain whether you would conduct open market purchases or sales in response to each of the following events. Justify your recommendation.

a. The latest FOMC Directive calls for an increase in the target value of the federal funds rate.
b. For a reason unrelated to monetary policy, the Fed’s Board of Governors has decided to raise the differential between the discount rate and the federal funds rate. Nevertheless, the FOMC Directive calls for maintaining the present federal funds rate target.

Answer 1

a. In this case, its goes for open market sales operations, This is because to increase the value of federal funds, the Fed has to reduce the money supply

b. In this case, its goes for open market purchase operation. This is because an increase in the differential between the discount rate and federal funds rate would encourage the depositary institutions to borrow money from Fed, thereby increasing the supply of money