Suppose you borrow $8,000 for one year and at the end of the year you repay the $8,000 plus $600 of interest. The expected inflation rate was 3.5% at the time you took out the loan, but the actual inflation rate turned out to be 2.5%
What was the expected real interest rate at the time of the loan? What was the actual real interest rate you paid? Who gained and who lost from the difference in the expected and actual inflation rates?
If you paid $600 of interest on a loan of $8,000, the nominal interest rate was 7.5%. If the expected inflation rate was 3.5%, the expected real interest rate was (7.5% - 3.5%) = 4%. If the actual inflation rate was 2.5%, the actual real interest rate was (7.5% - 2.5%) = 5%. You expected to pay a real interest rate of 4%, but actually paid a real interest rate of 5%, so you lost and the lender gained from the difference in the expected and actual inflation rates.
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