Fisher effect; what happen when actual inflation is not the same (higher or lower) than the...

Fisher effect; what happen when actual inflation is not the same (higher or lower) than the expected inflation

Expert Solution

Fisher effect says the real interest rate is equal to the difference between the nominal interest rates and inflation. It establishes a relation between the real interest rate and nominal interest rate and inflation.

If there is a difference between the actual inflation and expected inflation the real interest rate will rise or fall depending on the higher or lower the expected inflation is. For example, if the expected inflation is 10% and the real interest rate is just 5% the difference between the real and expected inflation will increase the real interest rate keeping the nominal rates same i.e. people will be getting a higher return on their deposit and it will lead to a transfer of wealth from the borrower to the lender.

Similarly, if the expected rate is lower than the actual inflation it will lead to a fall in the real interest rates and cause a transfer of wealth from the lender to the borrower.

Rahul Sunny answered 2 years ago

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