Question

last year you invested $100 in a savings account earning interest of 9% per year. if over the past year the overall price level in the economy decreased by 2%, what was the real interest rate during this period?

Answer 1

The real interest rate is calculated by adjusting the nominal interest rate for inflation or deflation. In this case, with a 9% nominal rate and 2% deflation, the real interest rate is 11%.

Step-by-step explanation:

The question at hand is concerned with understanding the difference between nominal interest rates and real interest rates. To calculate the real interest rate, you need to adjust the nominal interest rate by the rate of inflation or deflation. In the given scenario, you invested $100 in a savings account earning 9% per year, while the economy observed a deflation of 2%. Hence, the real interest rate would be the nominal interest rate (9%) minus the deflation rate (-2%).

Real Interest Rate = Nominal Interest Rate - Inflation Rate (where the deflation is considered as negative inflation)

Real Interest Rate = 9% - (-2%) = 9% + 2% = 11%

This calculation shows that due to deflation, your real earnings on the savings account were higher than the nominal interest rate. It's an important concept in finance since unexpected deflation can impact borrowers and lenders by changing the effective cost of borrowing.