With no inflation, a bank would be willing to lend a business firm $5 million at an annual interest rate of 4 percent. But if the of inflation was anticipated to be 3 percent, the bank would most likely charge the firm an annual interest rate of Multiple Choice 7 percent. 1 percent. 3 percent.

With no inflation, a bank would be willing to lend a business firm $5 million at an annual interest rate of 4 percent. But if the of inflation was anticipated to be 3 percent, the bank would most likely charge the firm an annual interest rate of Multiple Choice 7 percent. 1 percent. 3 percent.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

With no inflation, a bank would be willing to lend a business firm $5 million at an annual interest rate of 4 percent. But if the rate
of inflation was anticipated to be 3 percent, the bank would most likely charge the firm an annual interest rate of
Multiple Choice
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7 percent.
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Expert Solution

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The bank is more concerned about a real interest rate.

The real interest rate = Nominal interest rate - the rate of inflation.

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Nick 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% per year. The nominal interest rate on the bonds adjusts automatically to account for the inflation rate. The government taxes nominal interest income at a rate of 20%. The following table shows two scenarios: a low-inflation scenario and a high- inflation scenario. Given the real interest rate of 4% per year, find the nominal interest rate on Nick's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario. Inflation Rate Real Interest Rate Nominal Interest Rate After-Tax Nominal Interest Rate After-Tax Real Interest Rate (Percent) (Percent) (Percent) (Percent) (Percent) 1.5 4.0 8.0 4.0 Compared with higher inflation rates, a lower inflation rate will the after-tax real interest rate when the government taxes the quantity of investment in the economy and nominal interest income. This tends to…