Question

If the Fed has an interest-rate target, why will an increase in the demand for reserves lead to a rise in the money supply? Use a graph of the market for reserves to explain.

Short answer

An expansion in the demand for reserves will raise the federal funds rate

Step-by-step solution

Concept Introduction

The objective pace of the Federal assets$iff1$. The demand RD$1$and supply RS$1$of Reserves determine a market Equilibrium at $E$

Explanation 

Presently, there is an expansion in the demand for reserves that shifts the demand from RD1 to RD2. The current money supply is fixed so this raises the federal funds rate to iff2 and this goes beyond the target value

To keep the federal funds rate fixed at iff1, Fed has to raise the money supply/reserves from RS1 to RS2. This restores the targeted federal funds rate but an increase in the number of reserves will increase the money supply.

Graphical Representation

Below is the graph of the market for reserves to explain.

Final Answer

An expansion in the demand for stores will raise the government finances rate. The open market buy will then, at that point, cause the financial base and the cash supply to rising.