Pat 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% 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 20%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario. Given the real interest rate of 2% per year, find the nominal interest rate on Pat'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) 1.0 2.0 7.5 2.0 Compared with lower inflation rates, a higher inflation rate will (increase/decrease?) the after-tax real interest rate when the government taxes nominal interest income. This tends to (encourage/discourage?) saving, thereby (increasing/decrease?) the quantity of investment in the economy and (increase/decrease?) the economy's long-run growth rate.
Pat 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% 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 20%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario. Given the real interest rate of 2% per year, find the nominal interest rate on Pat'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) 1.0 2.0 7.5 2.0 Compared with lower inflation rates, a higher inflation rate will (increase/decrease?) the after-tax real interest rate when the government taxes nominal interest income. This tends to (encourage/discourage?) saving, thereby (increasing/decrease?) the quantity of investment in the economy and (increase/decrease?) the economy's long-run growth rate.
Chapter7: International Arbitrage And Interest Rate Parity
Section: Chapter Questions
Problem 3SBD
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Question
Pat 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% 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 20%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario.
Given the real interest rate of 2% per year, find the nominal interest rate on Pat'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)
|
| 1.0 | 2.0 |
|
|
|
| 7.5 | 2.0 |
|
|
|
Compared with lower inflation rates, a higher inflation rate will (increase/decrease?) the after-tax real interest rate when the government taxes nominal interest income. This tends to (encourage/discourage?) saving, thereby (increasing/decrease?) the quantity of investment in the economy and (increase/decrease?) the economy's long-run growth rate.
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