Dmitri 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.

Options in order (increase,decrease), (encourage,discourage), (increasing,decreasing), (increasing,decreasing)

12. Ination-induced tax distortions Dmitri receives a portion of his income from his holdings of interestbea ring 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 ination rate. The government taxes nominal interest income at a rate of 10%. The following table shows two scenarios: a lowination scenario and a highination scenario. Given the real interest rate of 4.5% per year, find the nominal interest rate on Dmitri's bonds, the aftertax nominal interest rate, and the aftertax real interest rate under each in Ha tion scenario. Ination Rate Real Interest Rate Nominal Interest Rate After-Tax Nominal Interest Rate After-Tax Real Interest Rate (Percent) (Percent) (Percent) (Percent) (Percent) 2.0 4.5 E E E Compared with lower ination rates, a higher ination rate will V the aftertax real interest rate when the government taxes nominal interest income. This tends to V saving, thereby V the quantity of investment in the economy and V the economy's longrun growth rate