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Lecture 7: IFP and FRUC
The Fisher Effect
•
Irving Fisher (1930):
Real interest rates are stable over time.
Inflationary expectations cause fluctuations in
nominal interest rates.
If expectations for future inflation change, the
nominal interest rates will also change so that
real interest rates remain stable.
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Lecture 7: IFP and FRUC
The Fisher Effect
Example:
•
Invest $1 in a real asset (one apple tree):
return is liquidated for $1(1+
r
)[1+
E
(
p
)],
where
r
is the real interest rate and
E
(
p
) is the
expected rate of inflation.
•
Invest $1 in a nominal asset:
return is liquidated for $1(1+
i
), where
i
is the
nominal interest rate.

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