Assuming the Fisher Effect holds, and given U.S. tax laws, an increase in inflation
A)increases the real interest rate and the after-tax real rate of interest.
B)increases the Real interest rate and the after-tax real rate of interest.
C)does not change the real interest rate but raises the after tax real rate of interest.
D)does not change the real interest rate but reduces the after-tax real rate of interest.

Question

Quizplus · Accepted Answer

The Fisher Effect posits that the nominal interest rate is the sum of the real interest rate and the expected inflation rate. Therefore, an increase in inflation does not change the real interest rate, as it is adjusted for inflation. However, because interest payments are taxed, the after-tax real rate of interest decreases as inflation increases, since individuals are taxed on nominal interest earnings, which do not account for inflation.

Assuming the Fisher Effect Holds, and Given U