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Implications of the changes in interest rates on the international Fisher effect.

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Implications of the changes in interest rates on the international Fisher effect.

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Currency Depreciation and Appreciation:

When a country's nominal interest rate increases, it often signals higher expected inflation.

Investment and Hedging Strategies:

Investors and financial institutions use the IFE to guide their decisions.

Policy Implications for Central Banks:

Central banks consider the implications of the IFE when setting monetary policies.

Empirical Evidence and Limitations:

While the IFE provides a theoretical framework, empirical evidence supporting it is mixed

Comparative Analysis and Real-World Examples:

Analyzing historical contexts of significant interest rate adjustments helps illustrate the IFE.

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Case 1. Home and foreign inflation and interest rate are similar

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Case 1. Home and foreign inflation and interest rate are similar

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There should be minimal expected changes in the exchange rate between their currencies.

Implications on imports: Stabled Costs and Consisten Volume

Implications on exports: Stable Competitiveness and Consistent Volume,

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According to the Fisher Effect, the nominal interest rate is the sum of the real interest rate and the expected inflation rate.

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Case 2. Home inflation and interest rate are higher compared to the foreign country.

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Case 2. Home inflation and interest rate are higher compared to the foreign country.

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Higher inflation in the home country will lead to its currency depreciating relative to the foreign country.

Implications on imports: Higher Costs and Reduced Volume

Implications on exports: Lower Costs for Foreign Buyers, Increased Competitiveness, Trade Balance Improvement.

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Case 3. Home inflation and interest rate are lower compared to the foreign country.

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Case 3. Home inflation and interest rate are lower compared to the foreign country.

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Lower inflation in the home country indicates that its currency will appreciate relative to a foreign country

Implications on imports: Lower Costs and Increased Volume

Implications on exports: Higher Costs for Foreign Buyers, Reduced Competitiveness, Trade Balance Worsening.

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Core Principles of the International Fisher Effect

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Core Principles of the International Fisher Effect

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The IFE builds upon the Fisher Effect, which states that nominal interest rates are the sum of real interest rates and expected inflation rates. When applied internationally, the IFE suggests that the difference in nominal interest rates between two countries should equal the expected change in their exchange rates. Essentially, if a country has a higher interest rate than another, its currency is expected to depreciate proportionately.

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After Brexit, if the UK had higher inflation and interest rates compared to the EU, the British pound would depreciate against the euro. This would result in more expensive European imports for the UK but cheaper British exports for the EU, potentially increasing UK exports to European markets​

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If the UK experiences higher inflation and interest rates compared to Japan, the British pound will depreciate against the Japanese yen.

This depreciation makes UK exports cheaper for Japanese buyers, increasing the UK's export volume to Japan.

Conversely, Japanese imports become more expensive for UK consumers, decreasing the volume of imports from Japan

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If both the US and Canada have similar inflation and interest rates, the USD/CAD exchange rate is expected to remain relatively stable.

This stability helps maintain consistent trade volumes between the two countries, which are major trading partners​