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# assign4-key - Suggested Answers for Assignment#4 Econ 102...

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Suggested Answers for Assignment #4 Econ 102 Fall 2008 University of California, Los Angeles A.C.S. Brown Throughout the article, there are few explicit distinctions made between "nominal interest rates" and plain "interest rates." The author does indicate when he intends the real interest rate, so whenever the interest rate comes up, assume it is the nominal rate. That should make reading this easier. 1. If you put \$1 in a bank, the bank pays you a predetermined rate of interest, say i . That nominal rate is to compensate you for two things: the fact that you don°t then have that dollar to spend today and also for the fact that when you get it back, that dollar may purchase less than it did before. That is, in±ation may have eaten away some of the dollar°s worth by the time you get it back. We can express this mathematically as nominal interest rate = real interest rate + in±ation rate or in the notation from Lecture 6, i = r + ° So if the in±ation rate increases without any change in the nominal interest rate, the real interest rate decreases, and vice versa. The important thing to remember is that the interest rate we see is made up of these two components. This means that the payments made at a ²xed nominal interest rate i will decrease as the in±ation rate ° increases. 2. Before I attack this question directly, let°s ²rst examine the calculations at the end of the fourth paragraph. When you have a mortgage, the government often reduces your e/ective tax rate in order to encourage home ownership. One way to implement this is by not taxing income used for mortgage payments. The article reports that tax relief on mortgage

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