Suppose the Federal Reserve (the Fed) announces that it is raising its target interest rate by 50 basis points, or 0.50%. It would achieve this by the . Use the green line (triangle symbols) on the preceding graph to illustrate the effects of this policy. Place the black point (plus symbol) on the graph to indicate the new equilibrium interest rate and quantity of money.
The sequence of events that results in a new equilibrium interest rate, after the Fed makes the change you selected, may be described as follows: Because there is money in the financial system, the quantity of money demanded , which means that bond issuers sell bonds. This process continues until the new equilibrium interest rate is achieved.
Suppose the Federal Reserve (the Fed) announces that it is raising its target interest rate by 50 basis points, or 0.50%. It would achieve this by reducing the quantity of money in the financial system.
Using the green line (triangle symbols) on the preceding graph, we can illustrate the effects of this policy. The green line represents the initial equilibrium interest rate and quantity of money.
After the Fed announces the increase in the target interest rate, there will be less money in the financial system. This decrease in the quantity of money will lead to a decrease in the quantity of money demanded by individuals and businesses.
As a result, bond issuers will find it harder to sell their bonds at the initial interest rate. In order to attract buyers, they will need to lower the price of the bonds, which in turn will increase the interest rate.
This process will continue until the new equilibrium interest rate is achieved. The new equilibrium interest rate will be higher than the initial rate, indicating that borrowers will have to pay more in interest to access loans and funds.
To illustrate the new equilibrium interest rate and quantity of money, we can place a black point (plus symbol) on the graph. This point will indicate the new interest rate that has been reached after the adjustments made by bond issuers. The quantity of money will be lower than the initial quantity due to the decrease in money supply.
Overall, the increase in the target interest rate by the Fed leads to higher interest rates and a decrease in the quantity of money in the financial system. This policy is usually implemented by the Fed to control inflation and encourage savings.