What is the Fisher Equation?

The Fisher Equation, developed by economist Irving Fisher, describes the relationship between nominal interest rates, real interest rates, and inflation. It states that the nominal interest rate is approximately the sum of the real interest rate and the expected inflation rate.

Key Components

• Nominal Interest Rate (i): The interest rate quoted by banks and financial institutions, not adjusted for inflation
• Real Interest Rate (r): The actual return on investment after accounting for inflation
• Inflation Rate (π): The rate at which the general level of prices for goods and services is rising

Applications

• Investment Analysis: Helps investors understand the real return on their investments
• Economic Policy: Used by central banks to set monetary policy
• Financial Planning: Assists in long-term financial planning and retirement calculations

Example Calculation

Important Considerations

• The equation assumes perfect markets and rational expectations
• In practice, other factors may influence interest rates
• The relationship becomes more complex during periods of high inflation
• The equation is widely used in financial markets and economic policy-making