In June 2018, the Federal Reserve Bank raised interest rates for the seventh time in three years, and signaled that two additional rate hikes would take place by the end of the year.

a. What direct effects do higher interest rates have on household and firm behavior?

b. One of the consequences of higher interest rates is that the value of existing bonds (both corporate bonds and government bonds) will fall. Explain why higher interest rates would decrease the value of existing fixed-rate bonds held by the public.

c. Some economists argue that the wealth effect of higher interest rates on consumption is as important as the direct effect of higher interest rates on investment. Explain what economists mean by “wealth effects on consumption” and illustrate with AS/AD curves.