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Suppose currently in country XY the interbank rate (federal funds rate) is 2.5% as set...

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Finance

Suppose currently in country XY the interbank rate (federal funds rate) is 2.5% as set by the current demand and supply in the market for reserves. The discount rate is set at 4.5%. The central bank pays 1.0% interest on reserves held by commercial banks. The current required reserve ratio is 18%, which commercial banks complain is too high.

(a). Based on the above information provided, sketch a well labeled diagram of the market for reserves to show the current equilibrium position.

(b). Suppose the central bank wishes to reduce the required reserve ratio (say to 10%) but wants to keep the interbank rate at 2.5%. Briefly discuss how (and show in separate market for reserves diagrams) how the central bank could use open market operations to ensure the interbank rate remains at 2.5%. Be brief but specific.

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