Relationship between Real Interest Rate and Income Tax - Essay Example

The y-intercept is located at point b which is just above the origin. At this point, the income tax is zero and the real interest rate is very low but not zero. The slope of the function is given by m= Δr/Δt. From the diagram below it can be noted that the rate of real interest increases with an increase in income tax and reduces with a decrease in income tax (Dai et al. 38).

The choice of y-intercept is at point b because at no time in the economy will the real interest rates be zero. The metrics used on the y-axis are sensitive to the bond market while the x-axis values consider income taxed on households. The slope represents the change in real interest rate with income tax (Dai et al. 37).

Government expenditure is an alternative independent variable in this model. Government expenditure is inversely related to real interest rates. An increase in government expenditure leads to an increase in money supply which would lead to a reduction in interest rates. A fall in government spending leads to a reduction in the money supply and in turn interest rate reduces (Dai et al. 42). Read More