Compared with higher inflation rates, a lower inflation rate will (Increase , De

Question

Compared with higher inflation rates, a lower 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 (Increase , Decrease)   the quantity of investment in the economy and (Increase , Decrease)   the economy's long-run growth rate.

8. Inflation-induced tax distortions Eric receives a portion of his income from his holdings of interest-bearing U.S. government bonds. The bonds offer a real interest rate of 4.5% 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 4.5% per year, find the nominal interest rate on Eric's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario. Inflation Rate (Percent) 2.0 7.0 Real Interest Rate Nominal Interest Rate After-Tax Nominal Interest Rate After-Tax Real Interest Rate (Percent) (Percent) (Percent) 4.5 4.5 Compared with higher inflation rates, a lower inflation rate will nominal interest income. This tends to the after-tax real interest rate when the government taxes saving, thereby the quantity of investment in the economy and the economy's long-run growth rate.

Explanation / Answer

Answer : Table showing relevant information as follows :

Compare with higher inflation rate , lower inflation rate will decrease the after tax real interest rate when the government taxes Nominal interest income. This tends discourage savings, thereby decreases the quantity of investment in an economy and decreases the economy long term growth rate.

Inflation rate Real interest rate Nominal interest rate After tax Nominal interest rate After tax real interest rate 2.0 4.5 6.5 6.5-0.65= 5.85 4.5-0.65=3.85 7.0 4.5 11.5 11.5-1.15= 10.35 4.5-1.15=3.35

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