If Jackson is paid an interest rate of 10 percent on his savings, but the inflation rate has risen to 20 percent, the purchasing power of his savings is _____.

Question

decreased by 20 percent

increased by 20 percent

decreased by 10 percent

increased by 10 percent

Answer 1

To determine the impact of inflation on Jackson's savings, we need to look at the real interest rate, which is adjusted for inflation. The real interest rate can be calculated using the formula:

\[ \text{Real Interest Rate} = \text{Nominal Interest Rate} - \text{Inflation Rate} \]

In this case:

• Nominal Interest Rate = 10%
• Inflation Rate = 20%

Plugging in the values:

\[ \text{Real Interest Rate} = 10% - 20% = -10% \]

A negative real interest rate indicates that the purchasing power of Jackson's savings has decreased. Since the rate is -10%, Jackson's savings have effectively lost 10% of their purchasing power.

Therefore, the correct answer is:

decreased by 10 percent.