Question

When the Fed increases the money supply to lower the federal funds rate, will the cost of capital to U.S. companies be reduced? Explain how the segmented markets theory regarding the term structure of interest rates (as explained in Chapter 3) could influence the degree to which the Fed’s monetary policy affects long-term interest rates.

Answer 1

The federal funds rate is basically is used to control the supply of funds available in the economy. If the federal funds rate is increase by the Fed, its becomes expensive to borrow in the short term medium. Thus, the federal funds rate lower down the supply of available money which increase the short term interest rate.