Easy question . Please answer a ~ d Inflation and taxes on asset income. Suppose

Question

Easy question. Please answer a ~ d

Inflation and taxes on asset income. Suppose that the tax rate on asset income is Tr. Suppose (as is true in the United States) that the tax is levied on nominal interest income. Assume (as is not entirely accurate) that the tax applies to the real returns on capital. What is the after-tax real interest rate on bonds? Consider a permanent, unanticipated increase in the money growth rate from u' to u. Jjdoes not change. What is the effect on the inflation rate, n? What is the effect on the after-tax real return on capital? What is the effect on the after-tax real interest rate on bonds? What happens to the nominal interest rate, j? Does it move one-for- one with n?

Explanation / Answer

1.a. Since real interest rate=nominal interest rate+tax-money supply growth , real interest on bonds will fall.

b. Nominal interest plus tax will reduce inflation and money supply will enhance it. So that it depends on net strength of the duo.

c. After tax return will rise and real interest payment rise will reduce return. Hence, here also it depends on relative strength.

d. If nominal interest plus tax exceeds the money supply growth then, real interest will rise. Nominal interest will surely rise. In this case it cannot be infered that both move one-to-one.

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