Course Materials Home Grades Personalized ReviewsDiscussion Money 2 Graded Assig
ID: 1158864 • Letter: C
Question
Course Materials Home Grades Personalized ReviewsDiscussion Money 2 Graded Assignment | Back to Assignment Due Sunday 06.24.18 at 11.00 PM Attempts: Average: /10 S. Inflation-Induced tax distortions Jamal receives a portion of his income from his holdings of interest-bearing U.S. govenment bonds. The bonds offer a real interest rate of 4.0% per year. The nominal interest rate on the bonds adjusts automatically to the inflation rate Suppose the government taxes nominal interest income at a rate of 10%. The following table shows two scenarios, a low-inflation scenario and a high-inflation scenario. Given the real interest rate of 4.0% per year, find the nominal interest rate on Jamal's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under eacth inflation scenario. Lower Inflation 1.0% 4,0% Higher Inflation 8.0% 4.0% Inflation Rate Real Interest Rate Nominal Interest Rate After-Tax Nominal Interest Rate After-Tax Real Interest Rate Compared with higher inflation rates, a lower inflation rate will the government taxes nominal interest income. This tends to quantity of investment in the economy and the after-tax real interest rate when saving, thereby the the economy's long-run growth rate Grade it NowExplanation / Answer
(1) Nominal rate = Real rate + Inflation rate
With lower inflation: 4% + 1% = 5%
With higher inflation: 4% + 8% = 12%
(2) After-tax nominal rate = Nominal rate x (1 - Tax rate) = Nominal rate x (1 - 0.1) = Nominal rate x 0.9
With lower inflation: 5% x 0.9 = 4.5%
With higher inflation = 12% x 0.9 = 10.8%
(3) After-tax real rate = After-tax nominal rate - Inflation rate
With lower inflation: 4.5% - 1% = 3.5%
With higher inflation = 10.8% - 8% = 2.8%
(4) A lower inflation rate will increase after-tax nominal interest rate. This tends to increase savings, thereby increasing the quantity of investment and increasing long-run growth rate.