Question

Tara deposits money into an account with a nominal interest rate of 6 percent. She expects inflation to be 2 percent Her tax rate is 20 percent. Tara's after-tax real rate of interest a. will be 2.8 percent if inflation turns out to be 2 percent, it will be higher if inflation turns out to be higher than 2 percent. b. will be 2.8 percent if inflation turns out to be 2 percent; it will be lower if inflation turns out to be higher than 2 c. will be 3.2 percent if inflation turns out to be 2 percent; it will be higher if inflation turns out to be higher than 2 if inflation turns out to be 2 percent; d. it will be lower if inflation turns out to be higher than 2 percent. percent. percent. right Cengace Leanina.

Answer 1

Answer:

(d) it will be lower if inflation turns out to be higher than 2 percent

Explanation:

As per Fisher's equation,

(1 + i) = (1 + r) (1 + π) ,

wherein, i denotes nominal rate of interest

               r denotes real rate of interest

               π denotes the rate of inflation

As per the information provided in the question,

(1 + .06) = (1 + r) (1 + .02)

solving this further, we get,

(1 + r) = $\frac{(1 + .06) }{(1 + .02)}$

⇒ (1 + r) = 1.0392

⇒ r = .0392 or 3.92%

This is real rate of interest before tax.

The after tax return would be r( 1 - t)

⇒ 3.92 (1 - .20)

⇒ 3.1372 or 3.2% approx

So, after tax real rate of interest will be 3.2% if inflation turns out to be 2% and it will be lower if inflation turns out to be higher than 2.