Question

Assume that in Azerbaijan, Alyana deposits $5,000 in the bank for a single year. Given the following cases, answer the questions.

 

CASE 1: inflation = 0%, nominal interest rate = 5%

CASE 2: inflation = 5%, nominal interest rate = 10%

CASE 3: inflation = 10 %, nominal interest rate = 15%

 

1. In which case does the real value of your deposit grow the most? 

 

Assume the tax rate is 30%. 

 

1. In which case do you pay the most taxes?

Compute the after-tax nominal interest rate,

then subtract inflation to get the after-tax real interest rate for    both cases.

Answer 1

1. The real value of your deposit will grow the same in all cases, because the real interest rate is 5% for every case.

2. You will pay the most taxes in case 3, because the nominal interest rate is the highest.