A bank account currently pays interest at a rate of 3% per year. The current inf

Question

A bank account currently pays interest at a rate of 3% per year. The current inflation rate is 2% per year. DO NOT USE EXCEL
a) If I invest some money in the bank account, then what is the real interest rate that I am earning?        
b) I open a new account today, deposit $10,000, and do not expect to make any deposits or withdrawals for the next two years. What will be my account balance at the end of two years expressed in  
Then-current dollars?      
Constant dollars?
c) If I decide to withdraw the entire balance in my account and close the account at the end of the two-year period, how much money will I actually get in my hand?

Explanation / Answer

a) Real interest rate = Nominal interest - Inflation = 3 - 2 = 1 %.

Conclusion:- Real interest rate = 1 %

b) Bank account balance at the end of two years:-

In terms of Current dollars = 10000 * (1.03)2 = 10000 * 1.0609 = $ 10609

In terms of Constant dollars = 10000 * (1.01)2 = 10000 * 1.0201 = $ 10201

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