Antonio 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 Antonio'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)
2.0 4.5 ____ _______ _______
9.5 4.5 ______ _______ _______
Compared with lower inflation rates, a higher inflation rate will (increase/decrease) the after-tax real interest rate when the government taxesnominal interest income. This tends to (encourage/discourage) saving, thereby(increasing/decreasing) the quantity of investment in the economy and (increases/decreases) the economy's long-run growth rate.
