Chapter 15.3, Problem 4R

To determine

To evaluate: If borrowing money is expense when fed raises the federal funds rate

Explanation of Solution

A contractionary monetary policy is when Fed increases rates. A higher rate of fed funds means that banks are less likely to borrow money to keep their deposits at the required amount. As a result they are lending out less money. The money they offer is going to be at a rate that is high, since they borrow money at rate that is higher. Since loans are more difficult to acquire and more costly, companies are less likely to borrow, a decline in corporate borrowing would slow the economy down.

Adjustable-rate mortgages can get more costly as this happens. Homebuyers can afford only small loans, which makes the housing market slow. Housing prices dropped. Homeowners in their homes have less equity, and feel poorer. We invest less, thereby weakening the economy down more.