Question

If interest rates are at a level of 1% and expected inflation is 2%, would you prefer saving or spending your money? Justify your answer.

Answer 1

I would prefer spending my money. Inflation is nothing but a depreciation in the value of money.

If the interest rates are just 1% and expected inflation in the economy will be 2% then it will erode the real value of money or the purchasing power of money will be reduced. Real interest rates = Nominal rates - Inflation. If the inflation is higher the real interest rates which we will get after saving will be lower.

If we are spending the same money right now we could purchase much more than what we could be able to purchase later after inflation. The real value of money due to inflation will be reduced by 1% because inflation is 1% higher than the interest rates by 1%,