1. Interest Rates & Inflation
What are real interest rates?

2. Unit Test #2 Block Period
50 Multiple Choice Questions
No Free Response or Study Guide
2 on-line practice tests
Test Review sheet (see website)
Review formula sheet
Topics: GDP, Unemployment, CPI, GDP Deflator, Inflation & Interest Rates

3. Interest Rates & Inflation
Real vs. Nominal Interest Rates

4. Interest Rates
Reflects the cost of borrowing money (or benefit of saving it!)
There are short term & long term interest rates
The Federal Reserve controls short term interest rates
Used by banks & currently = 0.0%
Long term interest rates are determined by inflation expectations
Currently = 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) ↓

5. Investments & Inflation
Inflation directly affects your real return on any investment
If a bond pays 2.5% interest, what is your real return?
“It Depends” on the rate of inflation!

6. Adjusting Interest Rates for Inflation
Nominal Interest Rate = Real Interest Rate + Expected Inflation
Reworking above formula: Real = Nominal – Expected Inflation
10-year Gov’t Bond Purchase $1,000,000
Nominal Interest Rate %
Nominal dollars per year: $25,000 (interest per year)
In 10-years: $1,000,000 principal paid back
If expected inflation = 2.0%:
The real interest rate is 0.5% (2.5% - 2%)
Purchasing Power ↑ $5,000 per year

7. Practice Test #3