Impact of Inflation on Savings Account Rates and Return

As we all know, it's not the amount of money you have in the bank, but what that money can buy that really counts. If you earn a high interest rate in the bank but prices are increasing at an even faster rate, then you are losing money, since in absolute dollars your savings will buy less. If you earn a low rate of return but prices are falling, then your real return is higher than it seems.

So, with this in mind, I decided to find out how savings rates have fared over the last year with inflation calculated into the return. The chart below shows the real average savings rate paid out by banks on the BestCashCow savings and money market rate table both before and after accounting for inflation (inflation numbers are CPI-U per the US Department of Labor).

The adjusted average savings rate today is actually above what it was for the first half of 2008. While the actual average savings rate was higher in the first half of 2008, inflation was also greater due to higher energy, food, and commodity prices. At the time, many thought that the goverment statistics were actually undercounting the impact of inflation, meaning that the real savings rate would have been higher.

From November 2007 through December 2007, the inflation-adjusted yield spiked dramatically as prices fell. Both the banking and credit crisis as well as the drop in the price of oil were responsible for this.

In January 2009, inflation ticked up a bit (.3%), bringing down the return that someone would earn from a savings account. Of course, these numbers are all averages. Not everyone purchases the same basket of goods used to calculate the CPI. But the general fact holds, if prices go up, the money you have in the bank is actually earning less. If prices decline, then your cash and what is it earning is worth more.

The golden scenario is one in which banks are paying high interest rates on savings accounts and CDs and the inflation rate is low. This existed for much of the 1990s and for some of the last decade (many would say these golden conditions are what led to the Tech and Real Estate bubbles). But looking at only the rate you are earning on your money and not the inflation rate distorts the real return you are earning.