You are earning .5% interest on a savings account while inflation is running 2% per year. Which statement is true?

You are earning .5% interest on a savings account while inflation is running 2% per year. Which statement is true?

• A. Your purchasing power is increasing by 1.5% per year.
• B. Your purchasing power is remaining the same.
• C. Your purchasing power is decreasing by 1.5% per year.
• D. Your savings will double in 14 years.

Answer: (C)

When earning 0.5% interest on a savings account while encountering an inflation rate of 2% per year, the real interest rate — which reflects the actual increase in purchasing power — must be considered. To find the real interest rate, you subtract the inflation rate from the nominal interest rate. In this situation, that would be 0.5% (interest) - 2% (inflation) = -1.5%. This indicates that for each year, the value of the money saved does not keep pace with rising prices, resulting in a decrease in purchasing power. Consequently, your purchasing power is actually decreasing by 1.5% each year due to inflation outpacing the interest earned on the savings account. This highlights the impact of inflation on savings, as even though you are earning some interest, it is not sufficient to counterbalance the loss of value due to inflation. Therefore, the statement regarding the decrease in purchasing power is accurate. The other options either misinterpret the relationship between interest and inflation or inaccurately describe the effects on savings, such as the claim about savings doubling, which does not apply in this scenario.

When earning 0.5% interest on a savings account while encountering an inflation rate of 2% per year, the real interest rate — which reflects the actual increase in purchasing power — must be considered. To find the real interest rate, you subtract the inflation rate from the nominal interest rate. In this situation, that would be 0.5% (interest) - 2% (inflation) = -1.5%. This indicates that for each year, the value of the money saved does not keep pace with rising prices, resulting in a decrease in purchasing power.

Consequently, your purchasing power is actually decreasing by 1.5% each year due to inflation outpacing the interest earned on the savings account. This highlights the impact of inflation on savings, as even though you are earning some interest, it is not sufficient to counterbalance the loss of value due to inflation. Therefore, the statement regarding the decrease in purchasing power is accurate. The other options either misinterpret the relationship between interest and inflation or inaccurately describe the effects on savings, such as the claim about savings doubling, which does not apply in this scenario.