What Is the Fisher Effect?

The Fisher effect was the first discovery by the famous economist Fisher to reveal the relationship between inflation expectations and interest rates. It pointed out that when inflation rates are expected to rise, interest rates will also rise. English name: Fisher Effect.

Fisher effect

Fisher effect expression formula:

Real interest rate = nominal interest rate-inflation rate

Swap the left and right sides of the formula, and the formula becomes:

Nominal interest rate = Real interest rate + Inflation rate

The rise in the nominal interest rate is exactly the same as the inflation rate. This conclusion is called the Fisher effect or

An important theory in parity theory is exchange rate parity. The theory is that when all currency deposits provide the same expected rate of return, the foreign exchange market is in equilibrium. Using the same currency to measure the condition that the expected return on any two currency deposits is equal is called the interest rate parity condition. (Paul R. Krugman, International Economics, Vol. 2, Same below P342)

The Impact of Fisher Effect on Enterprise Benefits

The author does not agree with the theory of exchange rate parity, because it is not realistic to link the expected return on currency holdings with the interest rate. People holding foreign currencies or domestic currencies do not simply use it as a deposit. The currency of the deposit is only one way of all the currency held by the currency holder. In addition, the currency can be invested in the capital market, the real economy, and the commercial trade. Therefore, the currency's income The rate is only a one-sided measure of interest rates on deposits.

First of all, the rate of return on money invested in the capital market, such as the stock market, is not only linked to interest rates but also to the rate of inflation. More importantly, it is linked to the overall economic growth rate of the country, so, Such a currency rate of return cannot be based solely on interest rates, but also inflation factors, as well as the economic benefits and various expectations of this country. This shows that the currency rate of return in this market must also consider inflation factors, as well as various factors. Expected factors, such as changes in the raw material market, but the most critical and core factor is the economic efficiency of the country-the issue of productivity.

Secondly, although the currency rate of return on direct investment in the country s real economy is related to the country s interest rate and inflation, the most important thing is that the industry invested in the country has a comparative advantage, that is, it has higher economic benefits. Or productivity, which is the key to measuring the return on such an investment.

In addition, investment in commodity trade is similar to direct investment in the real economy. Why does this commodity have a market and can be invested in arbitrage? , Because in international trade, this is not only related to demand, but also to the comparative advantage of this country in producing this product, that is to say, it is more efficient, that is, the rate of return on money invested in this field is the same as that of these two countries. Comparative advantage is related: productivity is related.

From the above, it can be seen that the lack of the theory of exchange rate parity is only related to the rate of return on currency holdings and interest rates, but in the field of international trade, the share of foreign currencies that are only deposits is very small. Both exist as a method of commodity trade and direct investment. This is the disadvantage of interest rate parity: it does not conform to reality and is too one-sided. Of course, the same one-sided theory of parity is the theory of relative purchasing power parity: considering the inflation rate of the two countries, the difference in prices may also be caused by changes in supply and demand, not just monetary factors.

By combining the two formulas of exchange rate parity and relative purchasing power evaluation theory, the Fisher effect formula ("International Economics" P394) is obtained. This formula shows that if other conditions remain the same, if a country's expected inflation The rate goes up. Eventually, the country's interest rate on currency deposits will rise in proportion; similarly, lower inflation is expected to eventually lead to lower interest rates. This long-term relationship between such inflation and interest rates is the Fisher effect. If there is a problem with parity theory, the formula for the Fisher effect that should be deduced from parity theory should also be problematic, but there are data studies that prove that from 1970 to 2000, in the three countries of the United States, Switzerland and Italy, The correctness can be verified in the relationship between inflation and interest rates. (International Economics P396) Why is this? This is because firstly, in the process of coordinating the two formulas, the exchange rate influencing factors are eliminated, just as the reference country is regarded as a constant standard. As a result, the Fisher effect becomes only within a single country. The relationship between the inflation factor and interest rates, while the productivity within a country is a constant and can be disregarded. This is a mistake of the Fisher effect formula: Without considering the exchange rate issue, there is a natural synergy effect between the twoinflation rate and interest rate.

Second, if the two countries are different, if trade is free and unprotected, this is also similar to each country: that is, productivity is the same, and it can also be regarded as a constant. However, the productivity of different developed and developing countries is different. If they pass through free trade and exchanges, they will be the same as above. If they are different, there is an error in the entire theory of exchange rate parity, which cannot be used to derive the Fisher effect.

Financial institutions respond to Fisher effect

In International Economics, there is a formula for total money demand: M / P = L (RY), where M: total money demand; P: price level; R: interest rate; Y: national income. It can be seen from the above relationship that prices are not only related to interest rates, but also to the total demand of the money market, and also to national income. This means that price is not only related to interest rates, but also related to monetary factors and economic productivity. Therefore, the theory of exchange rate parity and relative purchasing power parity is a very problematic theory.

If you do not consider transaction costs and trade barriers, an item should have the same price in different countries. Such a theory is more intuitively correct. To make up for the shortcomings of such a theory, International Economics introduced real exchange rates. That is, the nominal exchange rate is the ratio of the real exchange rate times the real prices of the two countries. The shortcoming of the law of one price is that it is too idealistic and static. It does not consider dynamic standards such as interest rate factors, currency factors, and productivity factors associated with the price of an item. This is the source of its shortcomings. That's why the real exchange rate was introduced. The introduction of the real exchange rate summarizes the gap between the nominal exchange rate and the effect of factors such as transaction costs, trade barriers, and productivity differences. However, the author forgot that the international and domestic markets that are related to exchange rates are two different markets. The same product has different prices in the international and domestic markets: see the book's theory of dumping. Of course, the consumption preferences of the international market and the domestic market are different, and they are also two important reasons for the difference in market prices. This means that supply and demand in the international market are also important factors in determining prices, but regardless of demand, supply Fortunately, why not solve these problems domestically, but seek to solve them in the international market, because there are comparative advantages, that is, there are differences in productivity, so the exchange rate problem must be linked to productivity. The author believes that if all economic shocks are monetary and the exchange rate is in line with relative purchasing power parity for a long time, but each international trade is carried out because of the existence of a comparative advantage, and it is a shock caused by different productivity, rather than simply Currency shock, can this be said that the exchange rate is in line with relative purchasing power parity for a long time? No. The contents of international economics, such as parity theory and the Fisher effect, require major revisions.

Fisher effect

Hikes and cpi

The nominal interest rate in each country is equal to the sum of the actual interest rate required by the investor and the expected inflation rate. The difference between the interest rates of the two countries is equal to the difference between the inflation rates of the two countries, which is called the Fisher equation. The Fisher equation can be used to predict the spot exchange rate under the floating exchange rate system, the international Fisher effect.

The international Fisher effect believes that the floating spot exchange rate will change with the nominal interest rate difference between the two countries. The magnitude of the change is the same as the interest rate difference, but in the opposite direction.

In 2007, Japan s benchmark interest rate was 0.5%, while the loan interest rate was around 1.5%, while the Australian deposit rate reached 6.25%. The huge spread transaction caused the Australian dollar to appreciate significantly, and the sharp appreciation of a country s currency will definitely cause more hot money inflows. Large-scale carry trades have led to a rise in the domestic price index, and inflation has forced banks to raise interest rates. The vicious circle eventually led to an economic crisis. Although this is only a theory, this is how the Southeast Asian financial crisis began.

Therefore, UBS predicts that the renminbi will appreciate by 6% in 2007 based on the difference between the highest and lowest interest rates. At present, China's interest rate after deducting interest tax is around 2%, and the appreciation rate cannot be controlled within 6%. Hot money from bad transactions will flow in even more.

Fisher effect

Rate hikes and inflation

Regarding the situation of "rich man Yu Fu, poor man Yu poor", the non-mainstream Swedish school economist Mülldal also discussed that his "cyclical accumulation cause and effect theory" speaks of such problems. Wealthy families, communities, and nations have more opportunities to invest in education and will have an advantage in the future. The poor do not have more opportunities to receive education, thus changing their plight. Mainstream economics doesn't care about this. I have no intention to speculate on the psychology of mainstream economists, but I can draw negative conclusions from Fisher's separation. Any individual can be regarded as a dual role: investing as a shareholder of a business-a shareholder of a company that invests in human capital; as a consumer, you can have your own consumption plan. Separated by Fisher, if there is a complete capital market, then shareholders and consumers can be dichotomized, that is, the decision of the company does not depend on the specific preferences of consumers. There is a single best advantage of a company's decision: The advantage is that the net present value of the marginal investment income is zero. In this example, it means that if the capital market is complete, each individual's investment in human capital does not depend on the individual's consumption plan. Therefore, children of the poor and children of the rich are independent of family income in terms of human capital investment. If Fisher's separation describes reality, then since the opportunity for education is independent of family income, we cannot conclude that the opportunity for wealth is positively related to family income, even if the opportunity for wealth is positively related to the opportunity for education.

However, the Fisher separation effect only gives an ideal analytical benchmark. No society can have a "complete" financial market. Especially developing countries that are deeply depressed by the financial situation. Therefore, it is obviously meaningless to talk about Fisher's separation and human capital theory for poor students and families unless the financial mechanism is developed. In China, the financial market is basically non-market-oriented, and it is a group of people who have the power and wealth to control financial credit resources.