Your friend has just started a savings account that is currently paying 5% interest. If inflation is expected to be 7% this next year, your friend will be earning a A) nominal return of 7% and a real return of 5%. B) nominal return of 5% and a real return of 5%. C) nominal return of 12% and a real return of 5%. D) nominal return of 5% and a real return of - 2%.

Question

Lillian Foster

Social Studies

18 October, 04:10

Your friend has just started a savings account that is currently paying 5% interest. If inflation is expected to be 7% this next year, your friend will be earning a A) nominal return of 7% and a real return of 5%. B) nominal return of 5% and a real return of 5%. C) nominal return of 12% and a real return of 5%. D) nominal return of 5% and a real return of - 2%.

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Devan Bird · Answer 1

The correct answer is "D) ".

Inflation is the sustained increase in the price of goods and services in a given economy. This means that if goods suffer from inflation in a given period, you will be able to buy less for the same money in the lapse of that period.

Your money is in the bank and grows 5% over a year. However, the price for goods and services (inflation) grows 7% during that same period. As a consequence, regardless of the growth of your savings (nominal return), you will have a reduction in your purchasing power of 2% (real return).