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Hi John, hope you are fine with all the mess around.
I have a simple question on Fisher effect and it looks stupid but still:
It assumes that the higher interest rate means nothing but higher inflation and therefore the currency with high interest rate will depreciate vs currency with lower interest rate.
Why is that conclusion valid and isn’t it exactly the opposite – currency with high interest rate attract investors, demand will rise and therefore currency will appreciate following market forces?
Just don’t understand the the theoretic base behind IFE.Thank you!
It is based on the idea that in the long-term people investing money in both currencies will get the same overall return. Although investing in the currency with the highest interest rate will receive more interest in that currency, at the same time that currency will depreciate – so in theory it works so as to end up with the same overall return.
It is not really reliable in real-life (especially in the short term) mainly because lots of other factors affect exchange rates.
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