The Irving Fisher Theory: The Fisher Effect Formula
sustained significant rise. The Fisher effect was first discovered by the famous economist Irving Fisher to reveal the relationship between inflation expectations and interest rates. It points out that when inflation is expected to rise, interest rates will also rise. In this case,
The Fisher Effect Formula
Real Interest Rate = Nominal Interest Rate - Inflation Rate
The left and right sides of the formula to look at, the formula becomes:
Nominal Interest Rate = Real Interest Rate + Inflation Rate In an economic system, the real interest rate is often constant, because it represents the actual purchasing power of you. In this case,Thus, when the inflation rate changes, in order to obtain the balance of the formula, the nominal interest
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Fisher hypothesized that there should be a long-run relationship in the adjustment of the nominal interest rate corresponding to changes in expected inflation. He postulated that the nominal interest rate consists of an expected“real” rate plus an expected inflation rate. The real rate of interest is determined largely by the time preference of economic agents and the return on the real investment. These factors are believed to be roughly constant over time, and therefore, a fully perceived change in the purchasing power of money should be accompanied by a one-for-one change in the nominal interest rate. (anonymous, long-run relation between interest rates and inflation, …show more content…
From the demand to consider: to raise interest rates, people want to save money to the bank, it will reduce people's demand for goods, which can ease the price rise, thus inhibiting inflation; From the supply to consider: raising interest rates, will increase the cost of capital enterprises, enterprises will reduce production, so that the supply will increase, will exacerbate the price rise, from can also be seen, increase interest rates, production growth rate will decrease, So that the inflation rate. From an international point of view: When a country to raise interest rates, the international hot money will flow, which is the money supply increased, which will exacerbate inflation. From the above analysis, we can see that raising the interest rate in the ideal completely closed condition can aggravate the inflation. But after adding other specific factors, the situation becomes
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