Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Fisher Effect

What it is:

The Fisher Effect is an economic hypothesis stating that the real interest rate is equal to the nominal rate minus the expected rate of inflation.

How it works (Example):

In the late 1930s, U.S. economist Irving Fisher wrote a paper which posited that a country's interest rate level rises and falls in direct relation to its inflation rates. Fisher mathematically expressed this theory in the following way:

R Nominal = R Real + R Inflation

The equation states that a country's current (nominal) interest rate is equal to a real interest rate adjusted for the rate of inflation. In this sense, Fisher conceived of interest rates, as the prices of lending, being adjusted for inflation in the same manner that prices of goods and services are adjusted for inflation. For instance, if a country's nominal interest rate is six percent and its inflation rate is two percent, the country's real interest rate is four percent (6% - 2% = 4%).

Why it Matters:

The Fisher effect is an important tool by which lenders can gauge whether or not they are making money on a granted loan. Unless the rate charged is above and beyond the economy's inflation rate, a lender will not profit from the interest. Moreover, according to Fisher's theory, even if a loan is granted at no interest, a lending party would need to charge at least the inflation rate in order to retain purchasing power upon repayment.

Related Terms View All
  • Natural Capital
    Let's say Company XYZ is a paper manufacturer. It owns 50,000 acres of forestland in...
  • Tenbagger
    Let's say Company XYZ is trading at $5 a share. John Doe buys 100 shares, costing $500....
  • Collateralization
    Let’s assume you would like to borrow $100,000 to start a business. Even if you have an...
  • Record Low
    For example, let's look at this random chart for Cicso Systems (CSCO). Note the jagged...
  • Qualified Mortgage Insurance Premium
    Let’s say John and Jane Doe buy a house. They obtain a mortgage to buy the home, but...