Suppose that David has $1000. In the beginning of a year he decided to put his money in a saving account with 5% interest rate per year. The CPI was 150 in the beginning of that year. He expected that the CPI would be 153 in the beginning of the next year. However, it turned out that the CPI was 156 in the beginning of the next year.
A) Calculate the inflation rate, the actual ex-post real interest rate, and the expected real interest rate.
B) Why the actual ex-post real interest rate is different from the expected interest rate? Explain what features of the economy can generate this gap.
C) Suppose David had another alternative. There was a one-year government bond at the beginning of the first year for $1,000. He would receive principal plus interest totaling $1,020 at the beginning of the next year.
According to his expectation, did David decide rationally on putting his money in the saving account instead of buying the bond?
What would have David decided if he could have known the true CPI in the beginning of the next year? Was he still willing to choose to put his money in the saving account?