The main reason the Fed cannot control the real interest rate is that
A)it cannot control expectations of inflation.
B)M1 fluctuates too widely to allow interest rates to be easily controlled.
C)M2 fluctuates too widely to allow interest rates to be easily controlled.
D)the real interest rate is mainly determined by the behavior of banks.

Question

Quizplus · Accepted Answer

The Fed cannot control expectations of inflation, which affects the real interest rate. The real interest rate is the nominal interest rate minus the expected inflation rate. If the Fed sets a certain nominal interest rate but inflation is higher than expected, the real interest rate will be lower than intended. Conversely, if inflation is lower than expected, the real interest rate will be higher than intended. Thus, expectations of inflation play a key role in determining the real interest rate and the Fed cannot completely control them.

The Main Reason the Fed Cannot Control the Real Interest