In the short run, 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, and they pass that cost onto consumers by raising interest rates on loans. This causes the real interest rate to rise, which in turn decreases investment because it becomes more expensive for businesses to invest in new projects. Therefore, choice C is correct - the real interest rate rises and investment decreases. Choice A is incorrect because investment does depend on the real interest rate, so it is affected. Choices B, D, and E are also incorrect because they do not accurately describe what happens in the short run when the Fed increases the federal funds rate.

In the Short Run, When the Fed Increases the Federal