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In an attempt to reduce interest rates during times of high inflation, a government allows banks to issue indexed term deposits upon which only the
In an attempt to reduce interest rates during times of high inflation, a government allows banks to issue "indexed term deposits upon which only the real interest earned is taxed. If inflation is at rate r, and the bank pays interest at real rate i', then on a one-year deposit of initial amount 1 an investor receives inflation-adjusted principal of 1+r, plus "real in- terest" on the inflation-adjusted principal of i'(1+r), for a to- tal amount paid at year end of (1+r)(1+i'). The investor pays tax only on the real interest paid [i.e., on i'(1+r). ] This is compared to the usual term-deposit situation in which inter- est at rate i is paid at the end of the year. Derive expressions in terms of i, i', r and tg, (where 0
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