what is the international fisher effect 
the international fisher effect ife is an economic theory stating that the expected disparity between the exchange rate of two currencies is approximately equal to the difference between their countries nominal interest rates 1understanding the international fisher effect ife the ife is based on the analysis of interest rates associated with present and future risk free investments such as treasuries and is used to help predict currency movements this is in contrast to other methods that solely use inflation rates in the prediction of exchange rate shifts instead functioning as a combined view relating inflation and interest rates to a currency s appreciation or depreciation the theory stems from the concept that real interest rates are independent of other monetary variables such as changes in a nation s monetary policy and provide a better indication of the health of a particular currency within a global market the ife provides for the assumption that countries with lower interest rates will likely also experience lower levels of inflation which can result in increases in the real value of the associated currency when compared to other nations by contrast nations with higher interest rates will experience depreciation in the value of their currency 2this theory was named after u s economist irving fisher 3calculating the international fisher effectife is calculated as e i 1 i 2 1 i 2 i 1 i 2 where e the percent change in the exchange rate i 1 country a s interest rate i 2 country b s interest rate begin aligned e frac i 1 i 2 1 i 2 approx i 1 i 2 textbf where e text the percent change in the exchange rate i 1 text country a s interest rate i 2 text country b s interest rate end aligned e 1 i2 i1 i2 i1 i2 where e the percent change in the exchange ratei1 country a s interest ratei2 country b s interest rate for example if country a s interest rate is 10 and country b s interest rate is 5 country b s currency should appreciate roughly 5 compared to country a s currency the rationale for the ife is that a country with a higher interest rate will also tend to have a higher inflation rate this increased amount of inflation should cause the currency in the country with a higher interest rate to depreciate against a country with lower interest rates 4the fisher effect and the international fisher effectthe fisher effect and the ife are related models but are not interchangeable the fisher effect claims that the combination of the anticipated rate of inflation and the real rate of return are represented in the nominal interest rates the ife expands on the fisher effect suggesting that because nominal interest rates reflect anticipated inflation rates and currency exchange rate changes are driven by inflation rates then currency changes are proportionate to the difference between the two nations nominal interest rates 5application of the international fisher effectempirical research testing the ife has shown mixed results and it is likely that other factors also influence movements in currency exchange rates historically in times when interest rates were adjusted by more significant magnitudes the ife held more validity however in recent years inflation expectations and nominal interest rates around the world are generally low and the size of interest rate changes is correspondingly relatively small direct indications of inflation rates such as consumer price indexes cpi are more often used to estimate expected changes in currency exchange rates 