Fisher Effect

The Fisher Effect describes the relationship between expected inflation and interest rates. It states that when people anticipate higher inflation, lenders will demand higher interest rates to compensate for the decreased purchasing power of future repayments. Conversely, if inflation is expected to be low or stable, interest rates tend to stay lower. This mechanism helps align real returns with inflation expectations, ensuring lenders and borrowers account for the changing value of money over time. Essentially, the Fisher Effect explains why nominal interest rates often move in line with expected inflation.