I Do What I Do

by Raghuram G. Rajan

The typical letter I get (from the retiree) goes, ‘I used to get 10 per cent earlier on a one-year fixed deposit, now I barely get 8 per cent’, please tell banks to pay me more else I won’t be able to make ends meet’. The truth is that the retiree is getting more today but he does not realize it, because he is focusing only on the nominal interest he gets and not on the underlying inflation which has come down even more sharply, from about 10 per cent to 5.5 per cent. To see this, let us indulge in Dosa economics. Say the pensioner wants to buy dosas and at the beginning of the period, they cost Rs 50 per dosa. Let us say he has savings of Rs 1,00,000. He could buy 2,000 dosas with the money today, but he wants more by investing. At 10 per cent interest, he gets Rs 10,000 after one year plus his principal. With dosas having gone up by 10 per cent in price to Rs 55, he can buy 182 dosas approximately with the Rs 10,000 interest. Now what happens when inflation comes down? At 8 per cent interest, he gets Rs 8,000 in interest. With dosas having gone up by 5.5 per cent in price, each dosa costs Rs 52.75, so he can now buy only 152 dosas approximately with the interest payment. So the pensioner seems right to complain: with lower interest payments, he can now buy less. But wait a minute. Remember, he gets his principal back also and that too has to be adjusted for inflation. In the high inflation period, it was worth 1,818 dosas, in the low inflation period, it is worth 1,896 d...