Wednesday, December 23, 2009

Two-Minute Drill -- Real Interest Rates

Summary: Real interest rates.

In January, 1981, the nominal interest rate on 1-year T-bills was 12.6%. The inflation rate in 1981 was 12%.

In January, 1999, the one-year T-bill rate was 4.5% and the inflation rate was 2%.

What was the real interest rate in each year? What year was the return in terms of a basket of goods the highest?

Answers: The real interest rate equals the nominal - expected rate of inflation. The real rate in 1981 was .6%. In 1999, 2.5%. In 1999, an investor would find that after adjusting for inflation, they could purchase a larger basket of goods than in 1981.

About the Author: Mike Fladlien is an AP Economics teacher from Muscatine High School in Muscatine, IA. He blogs at Mikeroeconomics.


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