What does the International Fisher Effect mean?

The International Fisher Effect (IFE) is an economic theory that says the difference between two currencies’ expected exchange rates is about the same as between their nominal interest rates.

Getting to know the International Fisher Effect (IFE)

The IFE looks at the interest rates on safe investments like Treasury bonds, both now and in the future. It is used to help guess how currencies will move. Unlike other methods that only look at inflation rates to guess how exchange rates will change, this one uses inflation and interest rates to determine whether a currency will rise or fall in value.

The idea behind the theory is that actual interest rates don’t depend on other monetary factors, like changes in a country’s monetary policy, and give a more accurate picture of how healthy a currency is in the global market. The IFE is based on the idea that countries with lower interest rates will probably also have lower inflation rates. This can cause the currency’s value to rise compared to other countries’ currencies. On the other hand, countries with higher interest rates will see their currencies lose value.

It was named for the American economist Irving Fisher.

How to Figure Out the International Fisher Effect

If country A has an interest rate of 10% and country B has an interest rate of 5%, then country B’s currency should gain about 5% compared to country A’s currency. The IFE is based on the idea that a country with higher interest rates will also have higher inflation rates. If inflation increases by this much, the currency of the country with higher interest rates should lose value against the currency of the country with lower interest rates.

The Fisher Effect and the Fisher Effect in Other Countries

There are some similarities between the Fisher Effect and the IFE, but they can’t be switched around. It is said that the Fisher Effect shows that nominal interest rates are made up of the expected rate of inflation and the real rate of return. The IFE builds on the Fisher Effect by saying that since nominal interest rates show how much inflation people think will happen and changes in the value of a currency are caused by inflation rates, then changes in the value of a currency are related to the difference between two countries’ nominal interest rates.

How the International Fisher Effect Is Used

Testing the IFE in the real world has yielded mixed results, and it’s possible that other things also cause changes in currency exchange rates. Looking back at history, the IFE was more beneficial when considerable amounts changed interest rates. However, inflation predictions and nominal interest rates have been low worldwide in recent years. As a result, changes in interest rates have also been small. Most of the time, direct measures of inflation rates, like the consumer price index (CPI), are used to guess how foreign exchange rates will change.

Conclusion

• The International Fisher Effect (IFE) says that changes in exchange rates can be predicted by looking at how nominal interest rates vary from country to country.
• The IFE says that countries with higher nominal interest rates have high inflation retention, which makes their currencies lose value against other currencies.
• In real life, there isn’t a lot of proof for the IFE, and these days, it’s more commonly estimated changes in the value of a cure directly only based on expected inflation.