International Fisher Equation:

IFE builds on the law of one price, but for financial transactions.
Idea: Expected returns to international investors who invest in money markets in their home
country should be equal to the expected returns they would get if they invest in foreign money
markets once adjusted for currency fluctuations. Exchange rates will be set in such a way that
international investors cannot profit from interest rate differentials.

Fisher effect: The Fisher Effect Nominal interest rate is made up of two components –A real
required rate of return and nn inflation premium equal to the expected amount of inflation

The IFE basis its premise on the concept that real interest rates are independent of all other
variables such as changes to the monetary policy. Thus, the real interest rates provide a better
indication of an economy's health.

Fisher equation assumes that real interest rate are common for all currencies otherwise there will
be an arbitrage opportunity. People will try to conduct interest arbitrage. Since IFE provides
equilibrium exchange rate so abitrage isnt possible when IFE holds.

In equilibrium, with no government interference, nominal interest rate differential will

approximately equal the the anticipated inflation differential. Thus, currencies with high inflation
rates should bear higher interest rates than currencies with lower low inflation rates This
relationship between anticipated exchange rate movements and the nominal level of interest rates
is called the International Fisher Effect.

According to IFE, as real interest is common in all countries around the world , the difference in
nominal interest rate will be due to inflation. Hence, economies that have lower interest rates
(nominal) will experience lower levels of inflation. This is expected to increase the real value of
the associated currency. Conversely, economies that have higher interest rates are expected to
experience a depreciation in the value of the currency.