Suppose the nominal interest rate is 6%, the tax rate on interest income is 30%, and expected inflation is 3%.(a)Calculate the expected real after-tax interest rate.(b)Calculate the expected real after-tax interest rate if the nominal interest rate falls to 4%.(c)Calculate the expected real after-tax interest rate if the tax rate increases to 50% (with the nominal interest rate at its original value of 6%).(d)Calculate the expected real after-tax interest rate if expected inflation increases to 5% (with the nominal interest rate at its original value of 6% and the tax rate at its original value of 30%).
What will be an ideal response?
The expected real after-tax interest rate is ra-t = (1 - t)i - expected inflation rate.
| (a) | Given the initial values, ra-t = (1 - .30).06 - .03 = 0.012 = 1.2%. |
| (b) | When i = 4%, ra-t = (1 - .30).04 - .03 = -0.002 = -0.2%. |
| (c) | When t = 50%, ra-t = (1 - .50).06 - .03 = 0.0 = 0.0%. |
| (d) | When expected inflation rate = 5%, ra-t = (1 - .30).06 - .05 = -0.008 = -0.8%. |
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