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Question

explain how increasing the interest rate could lead to price stability in an economy

Answer 1

The situation can only existed in medium run, not in short run. It is because when interest rate (i) +, cash rate -, due to Reserve Bank uses bonds to buy currency, +i > investment (I) -. Since I is an important component in GDP (Y), - I > price level - in the short run, ceteris parbius.
However, in the medium run, people may understand the situation (i -) and Reserve Bank may not want to set the price level in the steady point, it will sell currency by buying bonds. i - > cash rate + > I + Y +. Price level will go back to the previous level.