Final answer:
The Federal Reserve raises the Federal Funds Rate by conducting open market operations to sell government securities, thereby withdrawing money from the banking system and raising interest rates. This, in turn, affects the economy by making borrowing more expensive, possibly lowering spending and investment, which can reduce inflation but may also slow economic growth and increase unemployment.
Step-by-step explanation:
How the Federal Reserve Determines the Federal Funds Rate
When the Federal Reserve (the Fed) wants to raise the Federal Funds Rate (FFR), it does so through open market operations. This means the Fed sells government securities to reduce the amount of money in the banking system. As a result, banks have less excess reserve to lend to each other, which causes the interest rate to go up. The FFR is the interest rate at which banks lend money to each other overnight to meet reserve requirements. A higher FFR makes borrowing more expensive for banks, which typically pass on the higher costs to consumers and businesses through higher interest rates on loans and mortgages.
The long-term impact of raising the FFR filters through the economy in several ways. More expensive loans can lead to reduced spending and investment, which might cool down inflationary pressures. However, it might also slow economic growth and increase unemployment if businesses reduce investments and consumers cut back on spending. The Fed uses these mechanisms to control inflation and stabilize the economy.