Fisher Formula: Is only relation between nominal and real interest rate that simple?

Updated: Aug 19, 2019


Fisher formula shows the simple relationship between nominal and real interest rate. The gap between them is inflation rate. However, this formula indicates the impact on foreign exchange rate. We are here to explain.


Formula


Where,

i = nominal interest rate

r = real interest rate

h = inflation rate

Q: Which area of The Fisher Formula relevant?

A: The Fisher Formula is relevant under risk management.

Q: What is The Fisher Formula?

A: The nominal interest rate is made up of two parts: the real interest rate plus a premium for inflation.

Q: What does The Fisher Formula imply?

A: The nominal interest rate differentials between countries provide an unbiased predictor of future changes in spot exchange rates. A country with relatively higher nominal interest rate due to higher inflation, it’s currency is expected to depreciate against another country’s currency with relatively lower inflation.

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