The effect proposes that if the real interest rate is equal to the nominal interest rate minus the expected inflation rate, and if the realinterest rate were to be held constant, that the nominal rate and the inflationrate have to be adjusted on a one-for-one basis. Real interest rate = nominal interest rate - inflation rate. In simpleterms: an increase in inflation will result in an increase in the nominal interest rate. For example, if the real interest rate is held at a constant 5.5% and inflation increased from 2% to 3%, the Fisher Effect indicates that the nominal interest rate would have to increase from 7.5% (5.5% real rate + 2% inflation rate) to 8.5% (5.5% real rate + 3% inflation rate).
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First proposed by Irving Fisher, the Fisher effect explains the relationship between the real interest rate, then nominal interest rate, and inflation.
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