Final answer:
The Fisher effect explains the relationship between inflation expectations and nominal interest rates, where nominal rates adjust based on expected inflation to preserve the real rates of return for lenders.
Step-by-step explanation:
The effect that characterizes the relationship between inflation expectations and nominal interest rates is known as the Fisher effect. The Fisher effect states that the nominal interest rate is equal to the real interest rate plus the expected rate of inflation. In other words, when people expect higher inflation in the future, nominal interest rates tend to go up to compensate lenders for the anticipated loss of purchasing power of money over time. Conversely, when inflation expectations are lower, nominal interest rates will be lower because there is less need to compensate for decreased money value.