Achieving the goal of price stability with low and steady inflation allows the Fed to achieve other goals, such as stable interest rates and stable foreign exchange rates. If the Fed fails to achieve low and steady inflation, why will it be hard to achieve stable interest rates? A. Because the real interest rate includes an inflation premium. B. Because high inflation leads to tremendous decreases of nominal interest rates. C. Because low inflation leads to tremendous increases of nominal interest rates. D. Because the nominal interest rate includes an inflation premium.

The correct answer is D. Because the nominal interest rate includes an inflation premium.

Explanation:

If the prices of many of the items we buy go up, we lose purchasing power. In other words, with the money we have - income and savings - we cannot buy as much as before. This can trigger an upward spiral of prices. If everything becomes more expensive, we may have to request a salary increase from our company. To finance the increase in staff salaries, the company could react by raising its prices. If this happens in many companies, the prices of many items will rise more, which will feed the spiral. This situation makes planning savings and investments more difficult for individuals and businesses. In the face of a rapid loss of value, the public can lose confidence in the currency. These are just a few examples of the negative effects of high inflation rates.