Final answer:
The correct answer is C. The supply curve for reserves is vertical when the federal funds rate is below the discount rate, indicating no change in reserves supplied with changes in the rate. It is horizontal when the federal funds rate is above the discount rate, implying an infinite supply of reserves at the discount rate.
Step-by-step explanation:
When the federal funds rate is below the discount rate, banks prefer to borrow from each other rather than the Federal Reserve. Therefore, the supply curve for reserves becomes vertical, indicating that the quantity of reserves supplied is not sensitive to changes in the federal funds rate within this region. Conversely, when the federal funds rate is above the discount rate, banks prefer to borrow from the Federal Reserve. This leads to a horizontal supply curve for reserves at the discount rate level, suggesting that any additional demand at the federal funds rate above the discount rate can be met with an infinitive supply of reserves at the discount rate.
The Federal Reserve influences this dynamic by conducting open market operations, which can adjust the amount of reserves in the banking system and thus alter the federal funds rate. This mechanism is more precise and effective than discount rate adjustments at managing the economy.