International Fisher effect

The international Fisher effect (sometimes referred to as Fisher's open hypothesis) is a hypothesis in international finance that suggests differences in nominal interest rates reflect expected changes in the spot exchange rate between countries. The hypothesis specifically states that a spot exchange rate is expected to change equally in the opposite direction of the interest rate differential; thus, the currency of the country with the higher nominal interest rate is expected to depreciate against the currency of the country with the lower nominal interest rate, as higher nominal interest rates reflect an expectation of inflation.

The international Fisher effect is an extension of the Fisher effect hypothesized by American economist Irving Fisher. The Fisher effect states that a change in a country's expected inflation rate will result in a proportionate change in the country's interest rate, such that the Fisher effect:

can be arranged as

where

The hypothesis suggests that the expected inflation rate should equal the difference between the nominal and real interest rates in any given country, such that:

where

Assuming the real interest rate is equal across two countries due to capital mobility, such that ${\displaystyle \rho _{\$}=\rho _{c}}$, substituting the aforementioned equation into the expectations form of relative purchasing power parity results in the formal equation for the international Fisher effect:

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