Fisher Effect

Topics: Inflation, Nominal interest rate, Fisher equation Pages: 3 (741 words) Published: February 14, 2014
INTRODUCTION
In order to dig into the Fisher effect it is important to understand it origins and its logic first. The Fisher effect is a theory proposed by Irving Fisher. He was an economist who essentially described association or linkage between inflation as well as nominal and real interest rates. (Investopedia.com, 2014) Mr. Fisher in his theory stated “that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation.” (Investopedia.com, 2014) Beggs further explains that with the inflation of the monetary policy the shift would also impact the nominal interest rate to increase the same percent. (Beggs J., 2014) Organizations who hold operations outside of the United States use the so called Fisher effect to make decisions with respects to their across the border operations. The concept should be understood by anyone who is involved in the across the border operations. Its understanding allows making better and sound decisions with respects to the growth in a country that shows to be most favorable. If the real interest rate is 5%, the U.S. inflation rate is at 3%, and the inflation rate of the euro area (the countries that use the euro) is at 4%, what are the nominal interest rates for both the United States and the euro area? Interpret the calculation for your trainees. Understanding between nominal and interest rate is crucial in order to understand the impact of the calculation. Nominal interest rate is a rate as portrayed by any individual. For instance if one holds a savings account at the rate of 5%, that account holder will assume 5% more money in that account next year, assuming nothing has been taken out of the account.

Contrary to the nominal interest rate is the real interest rate which essentially takes into an account a purchasing power. To elaborate further the real interest rate tells us...
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