xplain the Fisher effect and its mechanics by walking the trainees through a ste
ID: 2744141 • Letter: X
Question
xplain the Fisher effect and its mechanics by walking the trainees through a step-by-step explanation in the following hypothetical situation:
If the real interest rate is 5%, the U.S. inflation rate is at 3%, and the inflation rate of the euro area (the countries that use the euro) is at 4%, what are the nominal interest rates for both the United States and the euro area? Interpret the calculation for your trainees.
What are at least 3 implications of exchange rate fluctuations for Axetem as they relate to marketing and production decisions?
Explanation / Answer
Fisher effect is an economic theory which describes the relationship between “Nominal Interest Rate”, “Real Interest Rate” and “Inflation Rate”. This theory proposes that the real rate of interest is untouched by expected inflation rate of the economy as both will equalized over a period of time through market arbitrage.
Formula: Nominal Rate = Real Rate + Inflation Rate
Nominal Interest rate for US = 5% + 3% = 8%
Nominal Interest rate for Euro Area = 5% + 4% = 9%
The above hypothetical example suggests that if inflation rate in US is 3%, prevailing nominal interest rate in the economy will be 8%, since real rate of interest is 5%. Same applies with Euro area as well.
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