International Fisher Effect - Derivation of The International Fisher Effect

Derivation of The International Fisher Effect

The international Fisher effect is an extension of the Fisher effect hypothesized by American economist Irving Fisher. The Fisher effect states that a change in a country's expected inflation rate will result in a proportionate change in the country's interest rate, such that the Fisher effect:

can be arranged as

where

is the nominal interest rate
is the real interest rate
is the expected inflation rate

The hypothesis suggests that the expected inflation rate should equal the difference between the nominal and real interest rates in any given country, such that:

where

could be substituted with any country's currency

Assuming the real interest rate is equal across two countries due to capital mobility, such that, substituting the aforementioned equation into the expectations form of relative purchasing power parity results in the formal equation for the international Fisher effect:

where

is the expected rate of change in the exchange rate

This equation can be rearranged as:

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Derivation of The International Fisher Effect - Example
... exchange rate 12 months from now according to the international Fisher effect? The effect estimates future exchange rates based on the relationship between nominal interest rates ... months from now To check this example, use the formal or rearranged expressions of the international Fisher effect on the given interest rates The expected ...

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