Question

d. Consider the relationship between interest rates and inflation.
(i) Explain the difference between real and nominal interest rates.
Answer:

(ii) If the Fed takes actions that will change interest rates, how is this likely to affect inflation?
Answer:

Answer 1

(i) The difference between the nominal and real interest rates makes sense only in conditions of inflation (increase in the general price level) or deflation (decrease in the general price level).

(ii) The Fed is changing interest rate targets up or down to achieve target levels of employment, stable prices and stable economic growth.

The Fed raises interest rates to lower inflation, and lowers rates to stimulate economic growth.