international Fisher effect

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International Fisher effect

States that the interest rate differential between two countries should be an unbiased predictor of the future change in the spot rate.

International Fisher Effect

In international finance, a theory stating that an expected change in the exchange rate between two currencies is roughly equivalent to the difference between their nominal interest rates. This is based on the Fisher hypothesis, which states that real interest rates are independent of monetary considerations. If this is true, then a state with a low nominal interest rate has a low inflation rate; likewise, a country with a high nominal interest rate has a higher inflation rate. The real value of the high interest rate country will depreciate over time, leading to a circumstance in which its exchange rate, in relation to the low interest rate country, will change approximately according to the difference between their interest rates. This theory is controversial because, in practice, currencies with higher nominal interest rates tend to have lower inflation than currencies with lower interest rates.

international Fisher effect

a situation where NOMINAL INTEREST RATES’ differentials between countries reflect anticipated rates of change in the EXCHANGE RATE of their currencies.

For example, if British investors anticipate that the US dollar will appreciate by, say, 5% per annum against sterling, then in order to offset the expected change in parity between the two countries, they would be prepared to accept an interest rate approximately 5% per annum less on a dollar-denominated financial security than that which could be expected on an equivalent investment denominated in sterling. From a borrower's viewpoint, when the international Fisher effect holds, the cost of equivalent loans in alternative currencies will be the same, regardless of the rate of interest.

The International Fisher effect can be contrasted with the domestic Fisher effect, where nominal interest rates reflect the anticipated real rate of interest and the anticipated rate of change in prices (INFLATION). The international equivalent of inflation is therefore changing exchange rates. See COVERED INTEREST ARBITRAGE.

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