Question

Suppose that, in February 2018, you had deposited $1000 in a saving account (and left it there until February of this year, 2019) and the bank paid an interest rate of 2% on the savings.

What nominal interest did you earn?

What real interest did you earn?

Was this a good decision on your part? Why or why not?

Answer 1

Amount Deposited = $ 1,000

Nominal Rate = 2%

After 1 year the amount will grow to

F = A(1+r)¹

F = 1000(1+0.02)¹

F = $ 1,020

Nominal interest earned = $ 20

Inflationary rate I USA during this time period = 2%

Real interest rate = Nominal interest rate- Inflation

Real interest rate = 2% - 2% = 0%

No the decision is not good as the investment is not earning anything additional. The real interest rate is zero. That is we are not earning anything in addition.

But the purchasing power is same as it was a year ago. This means you will be able to buy same amount of commodity as you were able to buy a year ago.

From investment point of view is not good but in terms of purchasing power it remains the same. That is buying power remains the same.

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