An increase in the interest rate reduces planned investment because the interest rate is the cost of borrowing to finance investment projects.
- The Fed's intention when raising the federal funds target rate is to raise the cost of credit across the board.
- Everyone ends up paying more in interest since higher interest rates make loans more expensive for both firms and consumers.
- The cost of borrowing is represented by interest rates, therefore when the Fed increases its target rate, borrowing money becomes more expensive.
- Mortgage rates increase as a result of banks having to pay more to borrow money and as a result of charging people and businesses more interest as well.
Why interest rates are increased?
- Higher borrowing costs eventually slow borrowing and thus economic activity.
- This should eventually slow inflation, which is the objective of central banks in raising interest rates.
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