Fisher effect

Fisher effect

A theory that nominal interest rates in two or more countries should be equal to the required real rate of return to investors plus compensation for the expected amount of inflation in each country.

Fisher Effect

A theory stating that real interest rates are independent of monetary considerations. According to the Fisher effect, a currency's real interest rate is equal to its nominal interest rate less the inflation rate. Thus, if the inflation rate rises, the real interest rate eventually rises as well; likewise, if inflation falls, the real interest rate will fall. See also: International Fisher Effect.

Fisher effect

The direct relationship between inflation and interest rates. Increasing inflationary expectations result in increasing interest rates.

Fisher effect

an expression that formally allows for the effects of INFLATION upon the INTEREST RATE of a LOAN or BOND. The Fisher equation, devised by Irving Fisher (1867–1947), expresses the nominal interest rate on a loan as the sum of the REAL INTEREST RATE and the rate of inflation expected over the duration of the loan:

where R = nominal interest rate, r = real interest rate and F = rate of annual inflation. For example, if inflation is 6% in one year and the real interest rate required by lenders is 4%, then the nominal interest rate will be 10%. The inflation premium of 6% incorporated in the nominal interest rate serves to compensate lenders for the reduced value of the currency loaned when it is returned by borrowers.

The Fisher effect suggests a direct relationship between inflation and nominal interest rates, changes in annual inflation rates leading to matching changes in nominal interest rates. See INTERNATIONAL FISHER EFFECT.