Question

What happens if FED (Central Bank of the USA) increases interest rates in the USA far above expectations?

Answer 1

The Central Bank changes interest rates to control the flow of money in the economy.

If FED increases interest rates far above expectations,the commercial banks will borrow at a higher rate of interest and thus they will lend it to the public on a higher rate.

The people will pay more on mortgages and viable loans which will lead to a shortage in their disposable income.A shortage in disposable income will mean that they will spend less on other non essentials.

The lack of disposable income of consumers will reduce profits of businesses further leading to a fall in their valuation.

A rise in interest rates will also lead to a higher discounting factor to ascertain valuations which will further reduce the value of businesses.

This will lead to a downturn in economy.