In economics, the Fisher hypothesis (sometimes called the Fisher effect) is the proposition by Irving Fisher that the real interest rate is independent of monetary measures, specifically the nominal interest rate and the expected inflation rate. The term "nominal interest rate" refers to the actual interest rate giving the amount by which a number of dollars or other unit of currency owed by a borrower to a lender grows over time; the term "real interest rate" refers to the amount by which the purchasing power of those dollars grows over time—that is, the real interest rate is the nominal interest rate adjusted for the effect of inflation on the purchasing power of the loan proceeds.
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The relation between the nominal and real rates is approximately given by the Fisher equation, which is
This states that the real interest rate (
If the real rate
Some contrary models assert that, for example, a rise in expected inflation would increase current real spending contingent on any nominal rate and hence increase income, limiting the rise in the nominal interest rate that would be necessary to re-equilibrate money demand with money supply at any time. In this scenario, a rise in expected inflation
Vulgar Explanation
If you deposit $100 in a bank where the interest rate is 5% next year, does this mean that you will be richer after a year? This is just a ideal hypothesis. If the inflation rate next year is 3% which means that you are richer but only for the 2% part. What's more, if the inflation rate is 6% next year, in the end of next year you need pay $106 for the product you can buy for only $100 this year and you can only draw $105 from the bank, which means you lost $1 for one-year's deposition.
Related concept
The International Fisher effect predicts an international exchange rate drift entirely based on the respective national nominal interest rates. A related concept is Fisher parity.