HW$\backslash$#$11($Ch$17)$

Back to Assignment

Attempts $3\mathrm{.}72$

Keep the Highest $\backslash (3\mathrm{.}7/4\backslash )$

$8.$ Inflation$-$induced tax distortions

Kevin recelves a portion of his income from his holdings of interest$-$bearing U$.$S$.$ government bonds. The bonds offer a real interest rate of $\backslash (4\backslash \%\backslash )$ 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 $\backslash (10\backslash \%\backslash ).$ The following table shows two scenarlos: a low$-$inflation scenario and a highinflation scenario.

Given the real interest rate of $\backslash (4\backslash \%\backslash )$ per year, find the nominal interest rate on Kevin's bonds, the after$-$tax nominal interest rate, and the after$-$tax real interest rate under each inflation scenario.

Compared with lower inflation rates, a higher inflation rate will the after$-$tax real interest rate when the government taxes nominal Interest income. This tends tc saving, thereby the quantity of investment in the economy and the economy's long$-$run growth rate.