The Fisher Model

The Fisher Model, developed by economist Irving Fisher, explains how interest rates connect to economic expectations. It suggests that the nominal interest rate (the rate you see) is made up of two parts: the real interest rate (the true cost of borrowing after adjusting for inflation) and expected inflation (how much prices are expected to rise). In other words, if people expect prices to go up, lenders will ask for higher interest rates to compensate for the decreased value of future money. This model helps us understand how inflation expectations influence borrowing and lending decisions in the economy.