Question

The chairman of the Fed gives a speech and hints that, at the next meeting of the Open Market Committee, the issues of a rapidly growing economy and preliminary indications of rising prices will have to be addressed. You are in the market for a new house and your mortgage broker calls to tell you that the interest rate on the $100,000, 30-year mortgage you applied for has just increased by a quarter of a percent. Why did the rate increase even though the Fed has not announced any rate change?

Answer 1

The rate has increased even though Fed has not announced any rate change because Fed had indicated in the statement that inflation needs to be controlled and it is a clear indication that Fed will reduce money supply in the future to increase the interest rate in the economy which will help in reducing the level of aggregate demand and thus reducing inflationary gap in the economy. This leads to commercial banks to increase their rate of interest because it is clear that Fed will increase interest rate in its next meeting. Thus, banks transmits the increase in the rate of interest to the borrowers to bring about price stability in the economy.