Question

Which of the following is not correct?a. If the inflation rate exceeds the nominal interest rate, then the purchasing power of an interest-earning deposit falls over time.b. If there is deflation, then the purchasing power of an interest-earning deposit rises by more than the nominal interest rate over time.c. The higher the rate of inflation, the smaller the increase in the purchasing power of an interest-earning deposit.d. The purchasing power of an interest-earning deposit can increase or decrease over time, but it cannot stay the same.

Answer 1

The incorrect statement is that the purchasing power of an interest-earning deposit cannot stay the same; it can remain unchanged if the nominal interest rate equals the inflation rate.

Step-by-step explanation:

The statement in question is: 'The purchasing power of an interest-earning deposit can increase or decrease over time, but it cannot stay the same.' This is not correct. The purchasing power of an interest-earning deposit can indeed remain unchanged over time if the nominal interest rate exactly equals the rate of inflation.

Inflation erodes the purchasing power of money over time. When the nominal interest rate is higher than the inflation rate, the real interest rate is positive, and the purchasing power of an interest-earning deposit increases. However, if the inflation rate exceeds the nominal interest rate, then the purchasing power decreases.

In the case of deflation, which is a negative rate of inflation, the purchasing power of money increases. If we have a nominal interest rate of 7% and deflation of 2%, the real interest rate effectively becomes 9%, and the deposit's purchasing power would rise more than the nominal interest rate suggested.