Asked by Robin Jolly on Jun 12, 2024
Verified
Assuming the Fisher Effect holds, and given U.S. tax laws, an increase in inflation
A) increases the real interest rate and the after-tax real rate of interest.
B) increases the Real interest rate and the after-tax real rate of interest.
C) does not change the real interest rate but raises the after tax real rate of interest.
D) does not change the real interest rate but reduces the after-tax real rate of interest.
Fisher Effect
The economic theory proposing that the real interest rate is independent of monetary measures, especially the nominal interest rate and the expected inflation rate.
Real Interest Rate
The rate of interest an investor expects to receive after allowing for inflation, showing the real gain of an investment.
After-tax Real Rate
The actual income rate of return on an investment, after accounting for inflation and taxes.
- Clarify how inflation impacts interest rates through an examination of the Fisher effect.
- Comprehend how taxation interacts with inflation and nominal and real interest rates.
Verified Answer
PT
Prentella TorrenceJun 17, 2024
Final Answer :
D
Explanation :
The Fisher Effect posits that the nominal interest rate is the sum of the real interest rate and the expected inflation rate. Therefore, an increase in inflation does not change the real interest rate, as it is adjusted for inflation. However, because interest payments are taxed, the after-tax real rate of interest decreases as inflation increases, since individuals are taxed on nominal interest earnings, which do not account for inflation.
Learning Objectives
- Clarify how inflation impacts interest rates through an examination of the Fisher effect.
- Comprehend how taxation interacts with inflation and nominal and real interest rates.