- This topic has 1 reply, 2 voices, and was last updated 1 year ago by
.
- Posts
I watched your lecture on fisher model but i am facing few confusing points like …
1) Fisher equation explains that inflation is the factor that stimulates the gap between nominal interest and real interest due to inflation effect?
2) Nominal interest is the estimated interest rate that will be earned on investments but it is estimated rate although real interest is the actual return investors make after accounting for inflation effect?
3) Nominal interest has not been accounted for inflation which means inflation is included in the nominal interest rate but we need to remove it in order to see the real return that our investment would be making after accounting the inflation?
4) Is it true in real life if we simply subtract the rate of inflation from our nominal interest rate earned on our savings account would give us the real interest that it would earned?
5) For example, we want to invest in savings account that give us the nominal interest of 3.25% while the inflation rate is 2% in our country.
If we rearrange the formula we would get.
(1+i) = (1+r) (1+?)
(1+r) = (1+3.25%) / (1+2%)
(1+r) = 1.26%This means that we would be actually earning 1.26% on our investment while we would lose 2% for inflation effect.
6) Can we use this equation for any other deep purpose that I may be neglecting. Please let me know?
Is that ALL correct?
The Fisher equation explains that inflation is the factor that stimulates the gap between nominal interest and real interest due to the inflation effect. It is calculated by subtracting the expected inflation rate from the nominal interest rate. The formula is expressed as (1 + nominal interest rate) = (1 + real interest rate) x (1 + expected inflation rate).
Yes, you are correct. Nominal interest is the estimated interest rate that will be earned on investments, but it is an estimated rate. On the other hand, real interest is the actual return investors make after accounting for the inflation effect.
That is correct as well. Nominal interest has not accounted for inflation, which means inflation is included in the nominal interest rate. To see the real return that our investment would be making after accounting for inflation, we need to remove it by using the Fisher formula.
In real life, if we simply subtract the rate of inflation from our nominal interest rate earned on our savings account, it would give us the real interest that it would earn. However, it is important to note that this is a simplified calculation and may not capture all the factors affecting the real interest rate.
Yes, in the given example, if the nominal interest rate is 3.25% and the inflation rate is 2%, we can rearrange the Fisher formula to calculate the real interest rate. By substituting the values into the formula, we get (1 + r) = (1 + 3.25%) / (1 + 2%), which simplifies to (1 + r) = 1.26%. This means that we would actually be earning a real interest rate of 1.26% on our investment, while the inflation effect would reduce the value of our investment by 2%.
The Fisher equation can be used for various purposes beyond calculating the real interest rate. It is commonly used in investment appraisal to discount cash flows and adjust for inflation. Additionally, it can be applied in macroeconomic analysis to understand the relationship between interest rates and inflation. However, it is important to consider other factors and limitations when using the Fisher equation for specific purposes.
- You must be logged in to reply to this topic.