Beat Inflation Now

Students need to understand what nominal interest rates are and how real interest rates are computed given inflation rates. They also need to have a firm understanding of the concept of opportunity cost.

This activity is appropriate for principles of macroeconomics courses.

The activity is meant for class sizes of 40 or less.
Allow approximately 30 minutes of class time - this includes 8 minutes for watching the video, 15 minutes for the group activity, and 5 to 7 minutes for the debrief.

Overview

In this group activity, students will have the opportunity to role-play as a personal financial analyst in providing practical advice to a client concerning how to offer protection from the ravages of inflation by potentially using I-Bonds offered by the U.S. Treasury.

Expected Student Learning Outcomes

Students will be able to calculate the real interest rate, differentiate it from the nominal interest rate, and grasp the concept of opportunity cost.

Information Given to Students

Beat Inflation Now

Assume many people are anxious to find ways to weather their savings and retirement funds from the ravages of inflation. While government bonds don't look like a really attractive investment vehicle, let's look at how they work and the pros and cons of owning them.

Below is a link to a page from the Treasury Direct website outlining the terms of I-Savings Bonds.

https://www.treasurydirect.gov/indiv/products/prod_ibonds_glance.htm

Read it carefully before beginning the exercise.

Video

Before presenting students with the prompt below, have them watch the following video but only show it up until 8:08 as the presenter will spill the beans and spoil the group activity by potentially answering some of the questions that are posed.

https://youtu.be/Q7Sw0y_Hbic


Since valuable information is provided after 8:08 in the video clip, it's advisable in this instance not to provide the link to students before class but play it during class time instead.

Prompt

Here is the scenario you are faced with. You are a young personal financial planner fresh out of college with your economics degree working for a client who is 60 years old and is five years from retirement. She is worried about her retirement savings which are largely tied up in stocks. The stock market has been behaving erratically, and she is also concerned about moving her funds from mostly stocks to money market mutual funds as it will likely not keep pace with inflation. She tells you that she wants to retire in five years but wants to ensure that she has at least $1,800,000 when she retires. She currently has $1,500,000. She has heard about I-Savings bonds that are offered through the U.S. Treasury as one of her friends told her it was a good idea. She needs solid advice from you. Which of the following pieces of advice would you recommend to her? Remember, you want to help her learn the pros and cons of investing in I-Savings bonds. That means that one or more of the following statements may provide her with useful information in making a good decision.

a. Let her know that if inflation remains steady between now and the end of the period indicated by the current rate, her real return rate will be zero percent. Don't worry about losing her as a client, remember, your job is to provide her with factual information that will help her.
b. If inflation rises above the amount stated on the bond between now and the end of the period she will earn a positive real rate of interest because she is protected by owning the I-bonds.
c. Let her know that this is the best way for her to protect her retirement portfolio because the interest rate offered in the I-Bond is much better than the rate of return on stocks so far this year, and therefore she will still be ahead of the game.
4. Advise her that even if inflation remains steady, it is still possible from an opportunity cost perspective that she will generate a negative return rate on the money she invests in I-Bonds. If this statement is confirmed, you will need to explain to her why this is the case.

Debrief

"a" is close to the best answer but ignores the opportunity cost of investing in I-Bonds. That is, she could have invested them in the stock market and earned a nominal rate over the bond rate, eating into her effective real rate of return. That's what makes "d" a superior answer because it considers the opportunity cost of investing in I-Bonds. "b" sounds good but remind students that the interest rate on the I-Bonds will only reset after the end of the guaranteed period, leaving her exposed to the higher inflation rate. "c" is the only answer that is patently false. It assumes that even if the stock market is doing better than the bond rate, it will continue to perform at that level during the holding period of the I-Bonds. There is also a hidden dimension that might get past students but is in plain sight - the fact that the I-Bonds offered through the Treasury have a maximum purchase amount of $10,000.

Assessing the student learning outcomes of this activity can be accomplished in several ways, but a highly effective one is having students frame the issues covered by posting two potential short answer questions on your learning management system that they will be required to respond to.

Short Answer Question #1

How is it possible that your employer gave you a substantial increase in pay for the upcoming year but at the same time for you to experience a decline in real income?

Short Answer Question #2

The Social Security Administration adjusts benefits to the consumer price index. What if it turns out that the CPI is biased upwards by one percentage point? How might this fact increase the real income of Social Security recipients?

The video below is a short clip that could be distributed to students beforehand in preparation for the activity. It was produced by Jacob Clifford of AC/DC Economics.

https://youtu.be/raDU_4M2uLg