Final answer:
The term structure of interest rates is shaped by factors such as inflation, money supply, and particularly Federal Reserve activities that influence the federal funds rate, which affects various other economic indicators.
Step-by-step explanation:
The term structure of interest rates is influenced by a variety of factors, including inflation, the money supply, and Federal Reserve activities. These elements interact in complex ways to determine the range of interest rates observed in financial markets. In particular, the Federal Reserve, through its open market operations, targets the federal funds rate, which has a direct impact on short-term interest rates and an indirect effect on longer-term rates such as those for 30-year mortgages or three-year car loans.
Changes in the federal funds rate can lead to a chain reaction, affecting other economic variables such as foreign exchange rates, employment, output, and prices of goods and services. This dynamic highlights the essential role of the Federal Reserve in shaping monetary policy and in turn, influencing the nation's money supply and its position in the global market, especially after departing from the gold standard in 1971.
Figure 28.10, which illustrates monetary policy using the federal funds interest rate, the unemployment rate, and the inflation rate, shows how different periods of policy have left their mark since the 1970s. This underscores how the Federal Reserve's targets, such as interest rates and money growth rates, guide shifts in monetary policy.