Fisher Effect

Published Dec 28, 2022

Definition of Fisher Effect

The Fisher effect is an economic theory that states that the real interest rate is equal to the nominal interest rate minus the expected inflation rate. It was named after the economist Irving Fisher, who first described this relationship between nominal, real and expected interest rates. Essentially, the Fisher effect states that there will always be a one-for-one adjustment of the nominal interest rate to the inflation rate.

Example

To illustrate the Fisher effect, let’s assume that the current nominal interest rate is 5% (i.e., the accounting interest rate), the real interest rate is 3% (i.e., the purchasing power growth rate), and the expected inflation rate is 2%. According to the formula from above, the real interest rate is equal to the nominal interest rate minus the expected inflation rate. Thus, 3% = 5% – 2%.

Why Fisher Effect Matters

The Fisher effect is an important concept in economics and finance. It is used to determine the real rate of return on an investment, which is the rate of return after adjusting for inflation. It is also used to calculate the real cost of borrowing, which is the cost of borrowing after adjusting for inflation. In addition, this effect is used to determine the real rate of return on a bond, which is the rate of return after adjusting for inflation. Finally, the Fisher effect is used to calculate the real rate of return on a stock, which is the rate of return after adjusting for inflation.