Monday 261019

 Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 10 Money and Prices in the Long Run
Chapter 29 of 36 Money Growth and Inflation
Section 14 of 29
…
The principle of monetary neutrality states:
· an increase in the rate of money growth
· raises the rate of inflation
· but does not affect any real variable, e.g. amount of goods produced
Interest rates link the present economy and the future economy through effects on saving and investment.
The nominal interest rate is the interest rate announced at your bank.
It tells you how much the number of dollars in your savings account will increase per year because of interest earned by it.
…
The real interest rate corrects the nominal interest rate for inflation.
It tells you how much the purchasing power of your savings account will increase per year.
The real interest rate is the nominal interest rate minus the inflation rate.
Real interest rate = nominal interest rate - inflation rate.
If your bank
· pays a nominal interest rate of 7% per year on savings accounts
· and the inflation rate is 3% per year
· the real interest rate is 4%
· the real value of your savings grows by 4% per year
…
We can rewrite:
real interest rate = nominal interest rate - inflation rate
equation to be
nominal interest rate = real interest rate + inflation rate
This shows the nominal interest rate is the sum of the real interest rate plus the inflation rate.
Looking at the nominal interest rate this way is useful because different economic forces determine the two terms on the equation’s right side.
See Figure C for real and nominal interest rates over the past 50 years.
…
right side of equation
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