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The Fisher effect describes the relationship between inflation, real interest rates and nominal interest rates. The nominal interest rate equals the real interest rates plus the expected inflation ratesIf nominal interest rate is constant, real interest rates will fall as inflation increases
Interest rates and exchange rates Fisher Effect - The Fisher effect describes the relationship between inflation, real interest rates and nominal interest rates. - The nominal interest rate equals the real interest rates plus the expected inflation rates - If nominal interest rate is constant, real interest rates will fall as inflation increases - i = r + I => r = i – I In a world of countries and unrestricted capital flows, the real interest rates will be the same. If they are not the same, arbitrage will equalize them For example, = 5%, = 10% The investor will borrow capital in US and invest it in Japan increases, decreses => = The differences in nominal interest rates is also = differences in expected rates of inflation International Fisher Effect (IFE) - a link between nominal interest rate and exchange rate - 2 countries, the spot exchange rates change in an equal amount but in opposite direction to the different nominal interest rates between 2 countries. Does IFE help predict future currency movement ? - In long run, there seem to be a relationship between nominal interest rate and spot exchange rate - In short run, IFE is not a good predictor . Interest rates and exchange rates Fisher Effect - The Fisher effect describes the relationship between inflation, real interest rates and nominal interest rates. - The nominal interest rate. between nominal interest rate and exchange rate - 2 countries, the spot exchange rates change in an equal amount but in opposite direction to the different nominal interest rates between. - The nominal interest rate equals the real interest rates plus the expected inflation rates - If nominal interest rate is constant, real interest rates will fall as inflation increases - i