INTERNATIONAL FISHER EFFECT

Meaning of fisher effect

An economic theory which states that the real interest rate equal the nominal interest rate minus
the expected inflation rate.
 Nominal interest rate:
 Value before an adjustment for inflation.
 The stated in a contract.
 The actual price.
 Real interest rate:
 Value after an adjustment for inflation.
 Constant dollars.
 Incorporates only productivity changes.
 HOW IT WORKS(EXAMPLE)
In the late 1930s US economist Irving Fisher wrote a paper which posited
that country’s interest rate level rises and falls in direct relation to inflation
rate. Fisher mathematical equation:

R Nominal=R Real+ inflation

For example; if a country’s nominal interest rate is 6% and inflation rate is

2%, the real interest rate is 4%.(6%-2%)
WHAT IS THE INTERNATIONAL FISHER EFFECT-IFE

An economic theory that states expected change in the current exchange

rate between any two currencies is equivalent to the difference between two
country’s nominal interest rate for that time.
Calculation=i1-i2/1+i2
where,
E=% change in exchange rate.
i1=country’s A’s interest rate.
i2=country’s B’s interest rate.
THE CRUCIAL ASSUMPTION OF THE IFE CAN BE
SUMMARIZED AS FOLLOWS:
 Perfect mobility of capital without any regulation or restriction by
government institutions, indicating trade barriers are eliminated.
 Investors are risk neutral; therefore, no risk premium is asked by them.
 Zero transaction costs, with no psychological barriers and transportation
costs so that investors are indifferent between counties.