Fisher equation

In financial mathematics and economics, the Fisher equation expresses the relationship between nominal
interest rates and real interest rates under inflation. Named after Irving Fisher, an American economist, it
can be expressed as real interest rate ≈ nominal interest rate − inflation rate.[1][2] In more formal terms,
where equals the real interest rate, equals the nominal interest rate, and equals the inflation rate, the
Fisher equation is . [3][4] It can also be expressed as [5][6] or

.[7][8]

Applications

Borrowing, lending and the time value of money

When loans are made, the amount borrowed and the repayments due to the lender are normally stated in
nominal terms, before inflation. However, when inflation occurs, a dollar repaid in the future is worth less
than a dollar borrowed today. To calculate the true economics of the loan, it is necessary to adjust the
nominal cash flows to account for future inflation.[9]

Inflation-indexed bonds

The Fisher equation can be used in the analysis of bonds. The real return on a bond is roughly equivalent to
the nominal interest rate minus the expected inflation rate. But if actual inflation exceeds expected inflation
during the life of the bond, the bondholder's real return will suffer. This risk is one of the reasons inflation-
indexed bonds such as U.S. Treasury Inflation-Protected Securities were created to eliminate inflation
uncertainty. Holders of indexed bonds are assured that the real cash flow of the bond (principal plus
interest) will not be affected by inflation.[10]

Cost–benefit analysis

As detailed by Steve Hanke, Philip Carver, and Paul Bugg (1975),[11] cost benefit analysis can be greatly
distorted if the exact Fisher equation is not applied. Prices and interest rates must both be projected in either
real or nominal terms.

Monetary policy
The Fisher equation plays a key role in the Fisher hypothesis, which asserts that the real interest rate is
unaffected by monetary policy and hence unaffected by the expected inflation rate. With a fixed real interest
rate, a given percent change in the expected inflation rate will, according to the equation, necessarily be met
with an equal percent change in the nominal interest rate in the same direction.

See also
Real versus nominal value (economics)
Yield
Yield curve
Interest rate
Inflation

References
1. Cooper, Russell and John, A. Andrew. Theory and Applications of Macroeconomics (https://2
012books.lardbucket.org/books/theory-and-applications-of-macroeconomics/s20-14-the-fish
er-equation-nominal-an.html). Creative Commons. Retrieved 4 April 2021.
2. Fisher, Irving (1907). The Rate of Interest. Mansfield Centre, CT: Martino Publishing (2009);
MacMillan (1907). p. Cover. ISBN 9781578987450.
3. Cooper and Andrew op cit.
4. Fisher op cit.
5. Cooper and Andrew op cit.
6. Fisher op cit.
7. Cooper and Andrew op cit.
8. Fisher op cit.
9. Cooper and Andrew op cit.
10. Neely, Michelle Clark. "The Name Is Bond—Indexed Bond" (https://www.stlouisfed.org/publi
cations/regional-economist/january-1997/the-name-is-bondindexed-bond#1). Federal
Reserve Bank of St. Louis. Retrieved 5 April 2021.
11. Hanke, Steve H. (1981). "Project evaluation during inflation, revisited: A solution to Turvey's
relative price change problem". Water Resources Research. 17 (6): 1737–1738.
Bibcode:1981WRR....17.1737H (https://ui.adsabs.harvard.edu/abs/1981WRR....17.1737H).
doi:10.1029/WR017i006p01737 (https://doi.org/10.1029%2FWR017i006p01737).

Further reading
Barro, Robert J. (1997), Macroeconomics (5th ed.), Cambridge: The MIT Press, ISBN 0-262-
02436-5.
Fisher, Irving (1977) [1930]. The Theory of interest. Philadelphia: Porcupine Press. ISBN 0-
87991-864-0.

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