Nick receives a profit of his income from his holdings of interest-bearing U.S.

Question

Nick receives a profit of his income from his holdings of interest-bearing U.S. government bonds. The bonds offer a real interest rate of 4% per year. The normal 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 4% per year, find the nominal interest rate on Nick's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario. Compared with higher rates, a lower inflation rate will the after-tax real interest rate when the government taxes nominal interest income. This tens to saving, therby the quantity of investment in the economy and the economy's long-run growth rate.

Explanation / Answer

hello there!!

Formula for this is

( 1+ Money or Nominal Interest Rate ) = ( 1+ Real Interest Rate) ( 1+ Inflation Rate )

(1+R)= (1+ 0.04) (1 + 0.015)

(1+R)= 1.04 * 1.015

R=1.0556 - 1

R= 5.56%

For second

R= (1+0.04) (1+ 0.08) - 1

R= 12.32%

After tax nominal interest rate= R*(1-tax rate)

for 1st *(1-0.20)

= 4.45%

for 2nd= 12.32 * (0.80)

=9.86%

After tax real Interest rate= Real interest rate * (1-tax rate)

= 4 * (0.8)

=3.2%

for both it will be same.

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