Fisher effect

Definition

The Fisher Effect describes the relationship between real interest rates, nominal interest rates, and inflation. According to this theory, nominal interest rates adjust to expected inflation to maintain a constant real rate of return.

5 Must Know Facts For Your Next Test

1. The Fisher Effect formula is: Nominal Interest Rate = Real Interest Rate + Expected Inflation Rate.
2. It implies that changes in expected inflation will result in proportional changes in nominal interest rates.
3. The Fisher Effect helps investors understand how inflation impacts their returns on investments.
4. Named after economist Irving Fisher who introduced the concept in his book 'The Theory of Interest'.
5. It plays a critical role in monetary policy and forecasting future economic conditions.

Review Questions

• What is the basic formula for the Fisher Effect?
• How does expected inflation impact nominal interest rates according to the Fisher Effect?
• Who introduced the concept of the Fisher Effect?

Related terms

Real Interest Rate: The rate of interest an investor expects to receive after allowing for inflation.

Nominal Interest Rate: The stated interest rate of a bond or loan without adjustment for inflation.

Inflation: The rate at which the general level of prices for goods and services is rising, eroding purchasing power.