Fisher Effect Lr

Literature Review

The Fisher effect states that nominal interest rate is equal to the expected inflation rate plus the expected real interest rate (Quoc, 2012). According to Ahmad (2010) fisher effect states that any variations in short-term interest rates are the reflection of expected inflation movements. From both arguments, this research papers conclude that fisher effect is in response to a change in the money supply and the nominal interest rate in tandem with changes in the inflation rate in the long run. Thus, in order to understand the Fisher effect, it's crucial to understand the concepts of nominal and real interest rates.

The relationship between nominal interest rate and real interest was firstly introduced by Ivrin Fisher (Quoc, 2012). Generally, nominal interest rates refer to the rate of interest prior to taking inflation into account. Depending on its application, an inflation and risk premium must be added to the real interest rate in order to obtain the nominal rate (www.investopedia.com). Text book explains that nominal interest rate is the rate of interest before the adjustment of inflation while the real interest rate is the nominal interest rate minus inflation. It’s explained that the real interest rate of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate. Both this interest rate can be found on the Fisher Effect long-run and short-run.

Quoc (2012) in his research explain that the long-run Fisher relationship states that a permanent change in inflation will lead to an equal change in the nominal interest rate and the real interest rate will remain unaffected in the long run. These definitely explain that in long run fisher effect, will lead to a change in the nominal interest rate while the real interest rate is remain unaffected. According to Mishkin (1991), a short-run Fisher effect indicates that a change in the interest rate is associated with an immediate change in the...