The December 13, 2005, press release of the Federal Open Market Committee (FOMC) stated that the FOMC “decided today to raise its target for the federal funds rate by 25 basis points to 4¼ percent.” The press release also stated: “In a related action, the Board of Governors unanimously approved a 25-basis point increase in the discount rate to 5¼ percent.” (Note: A basis point is one one-hundredth of a percentage point. So, there are 100 basis points in 1 percentage point.)
a. Using a graph of the federal funds market, show the equilibrium federal funds rate and the discount rate before the policy action of December 13, 2005, when the federal funds rate was 4% and the discount rate 5%.
b. Use your graph from part (a) to explain how the Fed would raise the federal funds rate by 25 basis points (¼%). Show in your graph the 25-basispoint increase in the discount rate. What policy action would the Fed use to bring about this increase in the target federal funds rate?
c. Today, would the Fed use the same policy action you described in part (b) to raise the federal funds rate? Briefly explain.