Question

Assume at the beginning of the year you purchased $100 worth of goods. Using the Fisher EffectIf the nominal Interest rate is 11.4500% and the rate of Inflation is expected to be 6.8000%how much new goods could you buy and the end of the year versus the beginning of the year?

Answer 1

International fisher effect shows the effect of inflation on nominal interest rate where it says real interest is calculated by offsetting the effect of inflation in nominal interest rate.So we can say real interest rate is equal to nominal interest rate less inflation.

1+r = (1+n)/(1+i)

Here

R= real interest rate

I = inflation

n = nominal interest rate

R = (1+0.1145)/(1+.068)-1

= 0.0435

4.35%

Value of goods bought today = $100

Value of this $100 at the end of year = 100 × 1.0435 = $104.35

So from $100 you can buy goods worth value $104.35 at the end of year as against the value of goods of $100 at the beginning of the year.