a Suppose you put 350 in a savings account that paid an annu

a Suppose you put $350 in a savings account that paid an annual interest rate of 3%, and that you expect the annual ination rate to be 1%.What do you expect the real future value of this account to be in 4 years (i.e. what is the ex-ante real return?)

b Continue with the previous question. Suppose you are now 4 years in the future, and you see that ination has actually been 2% over the past4 years. What was your ex-post real return?

Solution

Expected Real interest rate = Nominal interest rate - Expected Inflation rate

= 3% - 1%

= 2%

So, the account will grow at 2% real per year.

Real future value after 4 years = $350 x (1.02)⁴ = $350 x 1.0824 = $378.85

(b)

Ex-post real return = Nominal return - Actual return

= 3% - 2%

= 1%

NOTE: When the saving grows at the ex-post rate, future value = $350 x (1.01)⁴ = $350 x 1.0406 = $364.21