Irving Fisher's Theorem

Irving Fisher's Theorem, often associated with the Fisher Effect, states that if inflation (rising prices) occurs, nominal interest rates typically increase proportionally, leaving real interest rates—the true cost of borrowing—unchanged. In other words, when prices go up, lenders demand higher interest rates to compensate for the decrease in money’s purchasing power, ensuring that the real return they receive remains stable. This helps maintain equilibrium between inflation and interest rates, illustrating how monetary policy influences borrowing costs and economic activity.