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I have my own novice theory that bank pays you interest for your deposit so that the value of principal amount remains the same in the future (as due to inflation, the price of the commodity will rise and our principal amount will not be able to buy the same amount of things). Is this theory true.

Because if not, then I have to way to con the banks, this is how it will be done:

As we know that Rs 10 would have bought me more good (lets say that good is 1 kg of aluminium) in the year 2010 than in 2020 (which only gets us 800 gram of aluminium for the same amount). Now instead of depositing Rs 10 cash to banks (lets say interest is 10% per decade) I will deposit an equivalent amount of aluminium. So in 2020 I will have more aluminium at a premium price (i.e. 1.1 Kg aluminium at Rs 13.75 and compare it with the usual Rs 11 for cash deposit ). I will take advantage of both interest and inflation.

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  • $\begingroup$ Could you please elaborate? The bank pays you interest to get your deposit, which it loans out to others. You make a deposit to get interest (and security). Are you asking about the motivation of one of these players, the effect of inflation on the equilibrium interest rate or what exactly? $\endgroup$ – Giskard Jun 17 at 11:33
  • $\begingroup$ Is this the same thing as saying the real rate of interest on deposits should be zero? That is a testable hypothesis. $\endgroup$ – BKay Jun 17 at 14:11
  • $\begingroup$ @BKay Yes, I am asking that the interest given by the bank is to nullify the effect of inflation. If this is not their intention and if they accept some other goods as deposit (like aluminium in my example), then I have a way to extract more profit. $\endgroup$ – henceproved Jun 17 at 17:19
  • $\begingroup$ @Giskard In a certain sense I am asking the motivation for banks to give interest (which I believe is to offset the effect of inflation). If this is not their intention and if they accept some other goods as deposit (like aluminium in my example), then I have a way to extract more profit. $\endgroup$ – henceproved Jun 17 at 17:21
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The US doesn't have a long time series of deposit interest rates available for free. However, they do have one month CD data from 1966 to 2013. This is a short term loan to a bank, that pays a slightly higher interest rate than a savings account. It is widely available across banks and FDIC insured for smaller balances. The following figure compares those one month CD interest rates with the rate of inflation:

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The correlation coefficient between these two series is 0.72. So they do move together (which is not surprising). However, you can see that there are long periods where there are large differences between the two series. Sometimes these differences are positive and other times they are negative.

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