Suppose you just placed $100 in an interest bearing account paying 7% nominal interest. Inflation is...
Suppose you just placed $100 in an interest bearing account paying 7% nominal interest. Inflation is expected to be 4% per year. After one year, how many dollars will you have in your account? By what percentage will your purchasing power have increased in one year?
Homework Answers
The nominal value of the money place after 1 year will be 100 x (1 + 7%) = 107. Hence, you will have $107 in your account after one year. Purchasing power is measured by real value of money which adjusts nominal value for inflation. Since inflation is 4% next year, the real rate of interest is 7 - 4 = 3%. Hence real value of money or purchasing power is increased by 3%.
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