Bonds adjusts automatically to account for inflation rate

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Gilberto 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% 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 4% per year, find the nominal interest rate on Gilberto'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) 2.5 4.0 8.0 4.0 Compared with lower inflation rates, a higher inflation rate will decrease the after-tax real interest rate when the government taxes nominal interest income. This tends to discourage saving, there by decreasing the quantity of investment in the economy and decreasing the economy's long-run growth rate. Grade It Now Save & Continue Copyright Notices Terms of Use Privacy Notice Security Notice Accessibility

Reference no: EM131007759

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