Fisher hypothesis

The Fisher hypothesis is that, in the long run, inflation and nominal interest rates move together, meaning that real interest rates are stable in the long term. This is also called the Fisher effect.It was formulated by Irving Fisher.

The Fisher equation is:

n = i + r

where i is the rate of inflation
n is the nominal interest rate and
r is the real interest rate.

If the Fisher hypothesis is correct (the Fisher effect is real), then n and i move together, which means that r (the real interest rate) is stable in the long term.

The equation above is an approximation. The difference between this and the absolutely correct equation is very small unless either the interest rate or inflation is very high, or it is being applied over a long period of time. The accurate statement is:

1+n = (1+i)(1+r)

This can also be expressed using continuous compounding.

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