Fisher Effect


DEFINITION of 'Fisher Effect'

An economic theory proposed by economist Irving Fisher that describes the relationship between inflation and both real and nominal interest rates. The Fisher effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation.


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BREAKING DOWN 'Fisher Effect'

The Fisher effect can be seen each time you go to the bank; the interest rate an investor has on a savings account is really the nominal interest rate. For example, if the nominal interest rate on a savings account is 4% and the expected rate of inflation is 3%, then money in the savings account is really growing at 1%. The smaller the real interest rate the longer it will take for savings deposits to grow substantially when observed from a purchasing power perspective.

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  1. How does the Fisher effect illustrate returns on bonds?

    The Fisher effect illustrates the relationship between inflation, real interest rates and nominal interest rates by showing ... Read Full Answer >>
  2. How is the Macaulay duration related to fixed income markets?

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    Investment timing decisions are among the most challenging faced by investors as they have a significant impact on ultimate ... Read Full Answer >>
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