Question

Given recent inflation concerns, how do you think the Federal Reserve will respond? How would this impact the average WACC for firms in the US?

Answer 1

The recent inflation in US is rising and is above Federal reserve target rate. Given such concerns Fed may reduce money supply, however the Fed has to see that it may not result in a recession as economy has recently emerged from a double dip recession. To reduce money supply a central bank has to reduce the interest rates so that the funds are expensive and liquidity decreases in the economy. The decreased liquidity will help combat inflation

To do so fed may increase the benchmark rates to reduce money supply. This will result in increasing WACC for US firms as the loans will get expensive.