12. Inflation-induced tax distortions

Shen 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 nominalinterest income at a rate of 10%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario.