Hey Atul, you raise a very interesting question. If the FED raises rates and mortgage rates increase, the homeowner should demand more rent to maintain profitability of their homes. This is true in the long run, but history has shown another possibility. What if rates rise too quickly and rents are locked in (or there isn’t enough wage income in the area to support increased rents). In this scenario, the only way out is for homes to quickly decrease in value. This is exactly what happened in the 2008 crisis. Interest rates jumped and government fiscal spending decreased. The price level of homes became unsustainably high and many had to sell quickly.

This is true for businesses as well. As the interest rate increases, businesses that may have been profitable at low borrowing rates may not be profitable in high interest rate environments. This is why the theory suggests that increasing the interest rate will drive down investments, wages and ultimately spending (inflation) in the short run.