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How does the International Fisher Effect works? 

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How does the International Fisher Effect works? 

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In summary, the IFE provides a useful theoretical framework for understanding the relationship between interest rates and exchange rates, it should be viewed as a general guideline rather than a precise predictor of currency movements.

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What is the International Fisher Effect ?

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What is the International Fisher Effect ?

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The basic idea of (IFE) is that if the nominal interest rate in one country is higher than in another country, the currency of the country with the higher interest rate should depreciate relative to the currency of the country with the lower interest rate.

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Case 3. Mexico's inflation and interest rate are similar compared to Argentina

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Case 3. Mexico's inflation and interest rate are similar compared to Argentina

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In this case if both countries have similar nominal interest rates, investors may not have a strong incentive to shift their funds from one country to another based solely on interest rate differentials, however the inflation expectations can be a factor in currency movements.
If investors perceive that one country has a higher risk of inflation than the other, they may demand a higher return to compensate for that risk, which could lead to currency movements.

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Case 2. Mexico's inflation and interest rate are lower compared to Chile

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Case 2. Mexico's inflation and interest rate are lower compared to Chile

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In this case investors should seek higher returns on their investments and therefore invest in the country with higher nominal interest rates, which in this case is Chile. The increase in the demand of chilean pesos would appreciate their currency, resulting in a decrease in the relative price of Mexican goods and an increase in the relative price of Chilean goods, making Chilean exports relatively more expensive and Mexican exports relatively cheaper.

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Case 1. Mexico's inflation and interest rate are higher compared to Colombia

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Case 1. Mexico's inflation and interest rate are higher compared to Colombia

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Mexico should experience a depreciation of its currency, as well, this would imply a decreased demand of imports. On the other hand Colombia, would see an increase in the demand for imports, as consumers and businesses may find imported goods more attractive due to their relatively lower cost, The implication for trade between the two countries is that Mexican exporters may find it more difficult to compete with their Colombian counterparts, as their goods will be relatively more expensive in the Colombian market.

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a.	What implications would the IFE have on imports and exports? Should the domestic currency appreciate or depreciate?

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a.	What implications would the IFE have on imports and exports? Should the domestic currency appreciate or depreciate?

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If the IFE holds, then a country with a higher nominal interest rate should experience a depreciation of its currency, making its exports more competitive in foreign markets by making them relatively cheaper. At the same time, the same country's imports should become more expensive due to the weaker currency.