Assume an economy begins with zero inflation, a 25 percent income tax rate, and a real interest rate of 4 percent. If inflation rises to 4 percent, the nominal interest rate becomes_{--------------------} percent and the after-tax real interest becomes_{--------------------} percent.

Question

Quizplus · Accepted Answer

The nominal interest rate is the sum of the real interest rate and inflation, so it becomes 8% (4% real + 4% inflation). The after-tax real interest rate is calculated by adjusting the nominal rate for taxes and inflation: (1 - 0.25) * 8% - 4% = 2%.

Assume an Economy Begins with Zero Inflation, a 25 Percent