Final answer:
When the real interest rate on a loan is lower than expected, it means the borrower is effectively paying less. The real interest rate is calculated by subtracting the rate of inflation from the nominal interest rate. Unexpected deflation can lead to a higher real interest rate.
Step-by-step explanation:
When the real interest rate on a loan is lower than expected, it means that the borrower is effectively paying less for the loan than initially anticipated.
The real interest rate is calculated by subtracting the rate of inflation from the nominal interest rate. If there is unexpected deflation, the real interest rate will be higher, making the loan more expensive for the borrower.
Example:
If the nominal interest rate is 7% and the rate of inflation is 3%, then the borrower would be paying a 4% real interest rate.
However, if there is deflation of 2%, the real interest rate would be 9%.