Final answer:
The supply of reserves and the federal funds rate have an inverse relationship, controlled through the Federal Reserve's open market operations. By selling or buying Treasury bonds, the Fed can decrease or increase the supply of reserves, influencing the federal funds rate and consequently impacting the broader economy.
Step-by-step explanation:
The supply of reserves and the federal funds rate have an inverse relationship. When the Federal Reserve conducts open market operations such as selling Treasury bonds, this reduces the supply of reserves in the banking system, leading to an increase in the federal funds rate as banks compete for the fewer available reserves.
Conversely, when the Federal Reserve buys Treasury bonds, it increases the supply of reserves, which tends to lower the federal funds rate. The federal funds rate is a critical benchmark in the financial system, influencing other interest rates and reflecting the cost of overnight loans between banks.
Change in the federal funds rate can, therefore, have broader implications on economic variables including employment, output, and inflation. The Federal Reserve uses this rate, along with other monetary policy tools like the discount rate and reserve requirements, to steer the economy towards its desired outcomes.