Question

The Fisher effect is defined as the relationship between which of the following variables?

1) default risk premium, inflation risk premium, and real rates
2) nominal rates, real rates, and interest rate risk premium
3) interest rate risk premium, real rates, and default risk premium
4) real rates, inflation rates, and nominal rates
5) real rates, interest rate risk premium, and nominal rates

Answer 1

The Fisher effect is defined as the relationship between nominal rates, real rates, and the interest rate risk premium. It states that nominal interest rates will adjust to changes in expected inflation, resulting in changes in real interest rates.

Step-by-step explanation:

The Fisher effect is defined as the relationship between nominal rates, real rates, and the interest rate risk premium.

The nominal interest rate is the stated interest rate that represents the compensation for delaying consumption. The real interest rate is the nominal interest rate minus the rate of inflation, which adjusts for the inflationary rise in the overall level of prices. And the interest rate risk premium takes into account the borrower's riskiness.

So, the Fisher effect states that nominal interest rates will adjust to changes in expected inflation, resulting in changes in real interest rates.