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Real Interest Rates Please

Thursday, 09 September 2010 04:10

The NYT has a front page piece on how low interest rates are hurting people who live on their saving. While interest rates are low, it would have been worth noting that the inflation rate is also very low. This is important to take into account in this sort of discussion, since the inflation rate had typically been higher in prior decades.

The real interest rate, the interest rate minus the inflation rate is the true return to savers. If the interest rate is 3 percent and the inflation rate is 3 percent, then the real value of a person's savings would erode by by 3 percent a year, if they spent all of their interest. Currently the inflation rate is close to 1 percent, which means that the real value of savings is only be reduced by 1 percent annually if a person spends their interest.

Real interest rates are low at present, which is a deliberate policy, but just reporting on the nominal rates presents a distorted picture of the situation facing savers.


Comments (9)Add Comment
written by izzatzo, September 09, 2010 7:46
Journalists are really interested in real interest rates because they're real interesting, especially in terms of the real opportunity cost of money compared to real goods, the real cost of lending and saving, and the real discount rate for real present values of really reduced future income. Really.
Only if CPI means something
written by junkcharts, September 09, 2010 10:44
I understand the point about real rates but something has bugged me forever about using the CPI for this purpose. The core CPI removes volatile things like rent, food, gas, etc. right? And for a typical household those things account for a majority of their spending. Stripping out volatility serves a different purpose but makes this calculation misleading, doesn't it?
I have been wondering about this
written by Peter Wilson, September 09, 2010 8:01
Back in the 70s Econ class they said risk free interest rate is 4%. So I am thinking the current super low rates are part of the Conservative Nanny State plan. Dean, can you please speak to this and reconcile the differences from then and now. Thanks much and enjoy the blog.
written by Wes, September 10, 2010 5:50
Don't forget that interest is taxed. So the case of 3% inflation and 3% interest is not a wash.
I pity the current pensioners. Their savings are slowly confiscated by Helicopter Ben - but the banks are getting their bailout by virtue of relatively steep yield curve.

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The banks are getting their bailout by virtue of relatively steep yield curve.
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.