The Fed Delivers Biggest Interest Rate Hike in Decades to Combat Surging Inflation

EconEye Admin

4 years ago

The Federal Reserve escalated its battle against inflation with a 0.75% interest rate hike. Consumer prices are up 8.6% from a year ago. By sharply raising interest rates, the Fed hopes to tamp down consumer demand.—npr.org

Answer the following questions to check your understanding of the story.

1) How does the 0.75% interest rate hike influence the inflation rate?

When short-term interest rates rise, _____________, and the inflation rate falls.

a) the quantity of money demanded increases, so consumers hold more money and spend less

b) the long-term real interest rate rises, which decreases saving, wealth and consumption expenditure

c) the long-term real interest rate rises, which decreases consumption expenditure and investment

d) the quantity of bank deposits increases, so consumers hold more deposits and spend less

Wrong! - How does a rise in short-term interest rates influence the quantity of deposits and loans created by the banking system, and the quantity of money demanded? How does a rise in short-term interest rates influence long-term real interest rates?

Good Job! - When the short-term interest rate rises, the real interest rate rises through the next days, weeks, and months. The higher the real interest rate, the smaller is the amount of consumption expenditure and investment. Aggregate demand decreases, and the inflation rate falls.

2) Other than combating inflation, what effect can we expect to see from the Fed’s decision to raise interest rates?

Everything else remaining the same, we can expect to see ______________.

a) the Fed increasing bank reserves over the next six months

b) a decrease in the real GDP growth rate within one to two years

c) an increase in investment up to a year later

d) a falling unemployment rate within one to two years

Wrong! - What ripple effects occur when interest rates rise? Do bank reserves increase or decrease? Does investment increase or decrease? What happens to aggregate demand, real GDP growth, and the unemployment rate?

Good Job! - When the Fed raises interest rates, aggregate demand decreases up to a year later, and within one to two years, the real GDP growth rate slows.

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