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It can be described as the relationship between nominal interest rates and real interest rates and inflation expectations

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The nominal interest rate is the stated interest rate on a loan or investment without adjusting for inflation. It reflects the percentage return on an investment or the cost of borrowing.

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The real interest rate accounts for inflation, representing the actual purchasing power of interest earned or paid. It is calculated using the formula:

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Real Interest Rate= Nominal Interest Rate − Inflation Rate

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Inflation expectations indicate the rate at which people, companies, and investors believe prices will increase in the future. These expectations can impact economic behavior, affecting choices related to spending, saving, and investing.

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Influence of inflation on real rates: When inflation rises, the real interest rate typically falls if nominal rates remain constant. This decrease in real interest rates can stimulate borrowing and spending since the cost of borrowing (in real terms) is lower.

Central bank policy: Central banks often adjust nominal interest rates in response to inflation expectations. If they expect higher inflation, they may raise nominal interest rates to prevent the economy from overheating and to maintain price stability.

Investment decision: Investors seek to achieve a positive real interest rate (i.e., nominal rates higher than inflation) to preserve and grow their purchasing power. If inflation expectations increase without a corresponding rise in nominal rates, real returns on investments may diminish, discouraging saving and investment.

Expectations and behavior: If people expect higher inflation, they may demand higher nominal interest rates on loans, anticipating that the purchasing power of repayments will decrease over time. Conversely, if inflation expectations are low, nominal rates may also remain lower.

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Hayes, A. (2024, 21 agosto). Fisher Effect Definition and Relationship to Inflation. Investopedia. https://www.investopedia.com/terms/f/fishereffect.asp

Team, C. (2023, 22 noviembre). Fisher Effect. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/economics/fisher-effect/

World Bank Open Data. (s. f.). World Bank Open Data. https://data.worldbank.org/indicator/FR.INR.RINR