Let’s see just how much high expected inflation can hurt incentives to save for the long run. Let’s assume the government takes about one‑third of every extra dollar of nominal interest you earn. You must pay taxes on nominal interest. However, if you are rational, you will care mostly about your real, after‑tax interest rate when deciding how much to save. ?i ??=?Eπ=π 23×?23×i (23×?)−?(23×i)−π Nominal interest rate Inflation (no surprises) Nominal after‑tax return Real after‑tax return 15% 12% 10% -2% 6% 3% 12% 9% 90% 87% 900% 897%
Let’s see just how much high expected inflation can hurt incentives to save for the long run. Let’s assume the government takes about one‑third of every extra dollar of nominal interest you earn. You must pay taxes on nominal interest. However, if you are rational, you will care mostly about your real, after‑tax interest rate when deciding how much to save. ?i ??=?Eπ=π 23×?23×i (23×?)−?(23×i)−π Nominal interest rate Inflation (no surprises) Nominal after‑tax return Real after‑tax return 15% 12% 10% -2% 6% 3% 12% 9% 90% 87% 900% 897%
Chapter13: Inflation
Section: Chapter Questions
Problem 14SQ
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Question
Let’s see just how much high expected inflation can hurt incentives to save for the long run. Let’s assume the government takes about one‑third of every extra dollar of nominal interest you earn. You must pay taxes on nominal interest. However, if you are rational, you will care mostly about your real, after‑tax interest rate when deciding how much to save.
| ?i | ??=?Eπ=π | 23×?23×i | (23×?)−?(23×i)−π |
|---|---|---|---|
| Nominal interest rate | Inflation (no surprises) | Nominal after‑tax return | Real after‑tax return |
| 15% | 12% | 10% | -2% |
| 6% | 3% | ||
| 12% | 9% | ||
| 90% | 87% | ||
| 900% | 897% |
Calculate the nominal and real after‑tax return for each case.
Nominal interest rate = 6%, inflation = 3%
Nominal after‑tax return:
%
Real after‑tax return:
%
Nominal interest rate = 12%, inflation = 9%
Nominal after‑tax return:
%
Real after‑tax return:
%
Nominal interest rate = 90%, inflation = 87%
Nominal after‑tax return:
%
Real after‑tax return:
%
Nominal interest rate = 900%, inflation = 897%
Nominal after‑tax return:
%
Real after‑tax return:
%
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