Question

The Fisher Effect is a familiar economic theory in the domestic market. In words, define the Fisher Effect and explain why you think it is also appropriately applied to international markets.

Answer 1

The Fisher effect describes the relationship between interest rates and the rate of inflation. It proposes that the nominal interest rate in a country is equal to the real interest rate plus the inflation rate, which means that the real interest rate is equal to the nominal rate of interest minus the rate of inflation. The Fisher effect is an important tool by which lenders can gauge whether or not they are making money on a granted loan. Unless the rate charged is above and beyond the economy's inflation rate, a lender will not profit from the interest.