Expected Inflation and the Real Rates of Interest on Taxable and Tax-Exempt Bonds

Shalom Hochman and Oded Palmon

Journal of Money, Credit and Banking, 1987, vol. 19, issue 1, 90-103

Abstract: This paper analyzes the impact of inflation on rates of return on taxable corporate bonds and tax-exempt municipal bonds. The paper considers a differential tax system, where the tax rate depen ds on both the identity of the investor and the source of income. It also consid ers the possibility that inflation may induce investors to switch from holding one asset to holding another. It is demonstrated that while inflation should increase the (pre-personal tax) real rate of interest on taxable bonds, it should reduce the real rate of interest on tax-exempt bonds. Copyright 1987 by Ohio State University Press.

Date: 1987
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