Need help with inflation / interest rate problem?

Question

I was doing a homework problem on how inflation would affect savers and borrowers, but I don't get how savers would be hurt if they receive a fixed-interest-rate. Suppose that I'm a saver and have $100 in my bank and getting 5% interest payed to me, there is a 20% inflation, how would that hurt me? Inflation causes prices to go up, but my interest rate won't change if it is fixed?? I'm confused, somebody help me please!

Answer 1

You buy soda for $1 per can. with inflation at 20% it will cost $1.20 next year. With $100 you can buy 100 cans of soda. If you put the mnoney in the bank for a year you will have $105. You will be able to buy $105/$1.20 cans of soda or 87.5 cans of soda. your standard of living has fallen by 12.5 cans of soda

Answer 2

That's correct, if your interest rate is "fixed," it won't change.  I assume that the rates are stating are ANNUAL rates -- so while the amount of money in your account would grow by 5% per year, prices are growing by 20%.  You money has less real value if it does not grow by at least the rate of inflation.

 

So let's suppose that you want to buy a phone that costs $105 today.  So you put your $100 in the bank and figure that at the end of one year you'll have the $105 you need.  But with 20% inflation, the price will rise to $126 (20% more than $105).  You'll be even further behind!