Interest-Bearing Accounts

Definition

Interest-bearing accounts are financial accounts, such as savings accounts and certificates of deposit (CDs), that earn interest on the deposited funds over time. The interest rate offered by these accounts can be influenced by various factors, including real interest rates, which reflect the purchasing power of money, and international capital flows, where investors seek higher returns across different countries. Understanding how these accounts operate is essential for individuals looking to grow their savings while also considering broader economic implications.

5 Must Know Facts For Your Next Test

1. Interest-bearing accounts are typically offered by banks and credit unions and provide a safe way to earn interest on deposits.
2. The interest earned on these accounts is usually compounded, meaning that interest is calculated on both the initial principal and the accumulated interest from previous periods.
3. Real interest rates can affect the attractiveness of interest-bearing accounts; higher real rates generally encourage more saving and investment.
4. International capital flows can influence domestic interest rates as countries with higher returns may attract foreign investors, impacting local banks' ability to offer competitive rates.
5. The Federal Reserve's monetary policy decisions can also impact interest-bearing accounts by adjusting the federal funds rate, influencing overall market interest rates.

Review Questions

• How do real interest rates influence the attractiveness of interest-bearing accounts for savers?
  • Real interest rates significantly affect the appeal of interest-bearing accounts because they determine the actual return on savings after accounting for inflation. When real interest rates are high, savers earn more on their deposits, encouraging them to save rather than spend. Conversely, low or negative real rates might deter saving as individuals may feel their purchasing power is eroded over time. Therefore, understanding real interest rates helps individuals make informed decisions about saving.
• In what ways do international capital flows impact domestic interest rates and the yields on interest-bearing accounts?
  • International capital flows can have a major impact on domestic interest rates as countries that attract foreign investment often see an increase in demand for their currency, which can lead to higher local interest rates. If foreign investors seek better returns in a specific country, this increased competition can prompt banks to offer more attractive yields on interest-bearing accounts to retain and attract deposits. Consequently, changes in global capital movements can directly affect how much individuals earn from their savings.
• Evaluate how changes in monetary policy by central banks can affect both real interest rates and the appeal of interest-bearing accounts.
  • Central banks influence real interest rates through monetary policy tools such as setting the federal funds rate. When a central bank lowers this rate to stimulate economic growth, real interest rates typically decline, making borrowing cheaper but reducing the returns on savings in interest-bearing accounts. Conversely, if a central bank raises rates to combat inflation, real rates increase, enhancing the appeal of saving due to better returns. This interplay between monetary policy and real interest rates directly impacts consumers' decisions regarding saving versus spending.

Related terms

Real Interest Rate:

The real interest rate is the nominal interest rate adjusted for inflation, representing the true cost of borrowing and the true yield on savings.

Nominal Interest Rate:

The nominal interest rate is the stated interest rate on a financial product without adjusting for inflation.

Capital Flow:

Capital flow refers to the movement of money for investment, trade, or business production across borders, which can impact domestic interest rates and economic growth.