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Hi John,
I’m trying to get the difference between these 2 concepts straight in my head. I understand the Fisher Effect is the relationship between interest rates & expected rates of inflation. The international Fisher Effect is the prediction of future interest rates based on interest rates? Is this then the same as Interest Rate Parity or is there some subtle difference?
Many thanks.You are correct in saying the the Fisher effect is the relationship between interest rates and inflation rates (and we use it in project appraisal).
The International Fisher Effect is saying that future exchange rates will be determined by the relative interest rates in the two countries.
However, in the exam, interest rate parity determines forward rates.
When forecasting future spot rates then we use purchasing power parity (i.e. inflation rates).The International Fisher effect is saying that both should come to the same result (because inflation and interest rates should be connected) but apart from possibly writing that it is otherwise irrelevant in the exam.
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