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Federal Reserve Chairman Ben Bernanke cut the Federal Funds Rate again last week. That’s the sixth rate cut in as many months. What exactly does this mean? Well, without getting too technical, a rate cut generally means two things to fiscally responsible people like you and me:

1. A weaker dollar (in other words, the dreaded inflation)

2. Lower returns on Savings Accounts, Bonds and Certified Deposits (CD’s)

In other words, it sucks for savers – big time. See, ol’ Ben has been so aggressive with his rate cutting agenda that we’re now at the point where interest rates are nearing historical lows and inflation is at an 18 year high. US Rates are now the lowest in the world, save for Japan and Singapore (most definitely not something to be proud of!), and the US dollar is arguably at its weakest point in nigh-on 30 years.

Before we discuss the implications of this policy on you and me, a quick economics lesson is in order. It’ll be painless and short, I promise, and will serve you well in the future.

Nominal vs. Real Interest Rates

Basically there are two types of interest rates: Nominal Interest Rates and Real Interest Rates.

Nominal Interest Rates are interest rates before they’ve been adjusted for inflation. Whenever you see an advertised rate on Mortgages, Credit Cards, Car Loans, Certified Deposits, Blah blah blah… (you get the point), 99% of the time it’ll be the Nominal Interest Rate that you’re hearing about.

Real Interest Rates, on the other hand, are interest rates after they’ve been adjusted for inflation. In other words, Real Interest Rates are Nominal Interest Rates minus Inflation. They’re called ‘Real’ rates because they’re a far more reliable benchmark of the deal you’re *really* getting!

Sound complicated? It’s actually very simple.

An Example…

Let’s say you live in Imaginationland, where inflation is running at 2%, and you decide to put your money in a Certified Deposit. Your bank manager tells you that he can offer you a rate of 8% for a 12 month deposit. Not too shabby! Remember though, that’s the Nominal rate.

The Real rate is 8% minus Inflation of 2%. So the Real Interest rate on your CD is 6% – still good, but not quite as appealing as you first thought.

Back to Reality…

Armed with your new economic prowess you’ll soon find that things are a little less rosy here in the real world. With inflation running at anywhere between 4 and 7 percent, that ‘High Yield’ Savings Account promising you 3% interest per annum isn’t all it’s cracked up to be, that’s a Nominal Interest Rate.

Real Interest Rates, on the other hand, aren’t widely publicized, for obvious reasons. To work out

The result? A NEGATIVE Real interest rate on high yield savings accounts!