Rajiv receives a portion of his income from his holdings of interest-bearing U. S. government bonds. The bonds offer a real interest rate of 2.5% per year. The nominal interest rate on the bonds adjusts automatically to account for the inflation rate. 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 2.5% per year, find the nominal interest rate on Rajiv's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario.
Inflation Rate Real Interest Rate Nominal Interest Rate After-Tax Nominal Interest Rate After-Tax Real Interest Rate
(Percent) (Percent) (Percent) (Percent) (Percent)
2.0 2.5
7.5 2.5
Compared with higher inflation rates, a lower inflation rate will the after-tax real interest rate when the government taxes nominal interest income. This tends to saving, thereby the quantity of investment in the economy and the economy's long-run growth rate.
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Rajiv receives a portion of his income from his holdings of interest-bearing U. S. government bonds....
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