Janet Yellen gave testimony to the Senate Budget Committee on May 8th 2014. What is relevant for this test is that in the course of her testimony she said that she thought it would take between 5 and 8 years to unwind the feds balance sheet from $4.3 trillion to something more sustainable in the long term.
a.. Assume that initially the Fed's Balance sheet is $4.3 trillion and that the Fed Funds rate is at .25% which is the interest rate the Fed pays on reserves held at the fed. Also assume that the Discount rate is set at .75%. Also assume that the Federal Funds rate starts to rise once the quantity of reserves falls below $2 trillion
b. Show with a graph and a clear written explanation what will happen if the Fed pulls $2.5 trillion dollars for reserves out of the Federal Funds market.