When the Fed increases the federal funds rate,
A)there is no effect on investment because investment depends on the real interest rate.
B)the real interest rate falls,and investment increases.
C)the real interest rate rises,and investment decreases.
D)the real interest rate is unaffected,but investment still decreases.
E)the real interest rate rises,and investment does not change.

Question

Quizplus · Accepted Answer

When the Fed increases the federal funds rate, it becomes more expensive for banks to borrow money from other banks. As a result, banks are likely to increase the interest rates they charge customers for borrowing money. This increase in interest rates makes borrowing more expensive for businesses and consumers, leading to a decrease in investment. Additionally, the higher interest rates attract more foreign investment, which strengthens the demand for dollars and causes the exchange rate to appreciate. This appreciation makes U.S. goods more expensive for foreign consumers, dampening exports, which can also lead to a decrease in investment. Therefore, the real interest rate rises, and investment decreases.

When the Fed Increases the Federal Funds Rate