Presentation on theme: "Interest Rates & Inflation"— Presentation transcript:
1Interest Rates & Inflation What are real interest rates?
2Unit Test #2 Block Period 50 Multiple Choice QuestionsNo Free Response or Study Guide2 on-line practice testsTest Review sheet (see website)Review formula sheetTopics: GDP, Unemployment, CPI, GDP Deflator, Inflation & Interest Rates
3Interest Rates & Inflation Real vs. Nominal Interest Rates
4Interest RatesReflects the cost of borrowing money (or benefit of saving it!)There are short term & long term interest ratesThe Federal Reserve controls short term interest ratesUsed by banks & currently = 0.0%Long term interest rates are determined by inflation expectationsCurrently = 2.50% (10-year government bond)As Expected Inflation ↑ => long term interest rates ↑Bond prices move inverse to interest rates.bond prices ↓ => interest rate ↑Low interest rates are critical for a healthy economy (GDP)As interest rates ↑ => cost of borrowing money ↑ => Investment (I) ↓
5Investments & Inflation Inflation directly affects your real return on any investmentIf a bond pays 2.5% interest, what is your real return?“It Depends” on the rate of inflation!
6Adjusting Interest Rates for Inflation Nominal Interest Rate = Real Interest Rate + Expected InflationReworking above formula: Real = Nominal – Expected Inflation10-year Gov’t Bond Purchase $1,000,000Nominal Interest Rate %Nominal dollars per year: $25,000 (interest per year)In 10-years: $1,000,000 principal paid backIf expected inflation = 2.0%:The real interest rate is 0.5% (2.5% - 2%)Purchasing Power ↑ $5,000 per year