The Fisher equation is a financial formula that relates nominal interest rates, real interest rates, and inflation rates. It states that the nominal interest rate is equal to the sum of the real interest rate and the expected inflation rate.
Mathematically, the Fisher equation can be written as:
Nominal interest rate = Real interest rate + Expected inflation rate
where:
- Nominal interest rate: the interest rate quoted by lenders and paid by borrowers, expressed as a percentage.
- Real interest rate: the nominal interest rate adjusted for inflation, representing the purchasing power of the interest earned or paid.
- Expected inflation rate: the rate at which the general price level of goods and services is expected to rise over a certain period of time.
The Fisher equation is important because it provides a way to compare nominal interest rates across different periods and economies. For example, if two economies have the same nominal interest rate but different inflation rates, the economy with higher inflation will have a lower real interest rate, meaning that the return on investment will be lower after accounting for inflation.
The Fisher equation is named after Irving Fisher, an American economist who first proposed the concept in the early 20th century.
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