Fisher effect

Definition

The effect proposes that if the real interest rate is equal to the nominal interest rate minus the expected inflation rate, and if the real interest rate were to be held constant, that the nominal rate and the inflation rate have to be adjusted on a one-for-one basis. Real interest rate = nominal interest rate - inflation rate. In simple terms: 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).

Use Fisher effect in a sentence

The fisher effect was used to explain the behavior of the interest rates as they related to inflation in the economy.

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I did not want to do anything that might have the fisher effect because I did not like it at all and wanted to to remain outside of our day to day activities.

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When they were looking at interest rates on bonds, they knew if the inflation rate started to increase then the nominal rate would need to increase to offset it due to the Fisher Effect.

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