Suppose I borrowed $100 of principal that must be repaid at the end of two years, along with interest of 4% a year. If the annual inflation rate turns out to be 8%
What is the real rate of interest on the loan?
r=n-I, where r – real rate of interest, n – nominal rate of interest, i – inflation. r=4%-8%=- 4%. It means the real value of the money will have actually decreased, as the real interest rate would be -4%, after accounting for inflation.