Suppose that, in March 2018, you had deposited $1000 in a savings account (and left it there until March of this year) and the bank paid an interest rate of 2% on that savings. What nominal interest rate did you earn? What real interest rate did you earn? Was it a good decision on your part, why or why not?
Nominal interest rate = Stated interest rate = 2%
US inflation rate from March 2018 to Feb 2019 (data source: Trading Economics website) and average monthly inflation rate is as follows.
Month | Inflation Rate (%) |
Mar-18 | 2.4 |
Apr-18 | 2.5 |
May-18 | 2.8 |
Jun-18 | 2.9 |
Jul-18 | 2.9 |
Aug-18 | 2.7 |
Sep-18 | 2.3 |
Oct-18 | 2.5 |
Nov-18 | 2.2 |
Dec-18 | 1.9 |
Jan-19 | 1.6 |
Feb-19 | 1.5 |
AVERAGE (%) = | 2.35 |
Real interest rate = Nominal interest rate - Average monthly inflation rate = 2% - 2.35% = -0.35%
Since real interest rate is negative, I took a wrong decision by investing at 2%.
However, if only inflation rate of Feb 2019 is considered, then
Real interest rate = Nominal interest rate - Monthly inflation rate of last month = 2% - 1.5% = 0.5%
Since real interest rate is positive, I took a correct decision by investing at 2%.
Get Answers For Free
Most questions answered within 1 hours.