Definition
Fisher Open / International Fisher Effect
The international Fisher effect predicts that the currency of a country with higher nominal interest rates will depreciate against one with lower rates, by roughly the interest gap.
Because higher nominal rates usually reflect higher expected inflation, the international Fisher effect says a high-rate currency like the rupee should weaken over time against a low-rate one like the dollar, offsetting the rate advantage.
This links the domestic Fisher effect to exchange rates and underpins uncovered interest rate parity. It is why carry trades carry hidden currency risk: the extra interest can be eroded by the predicted depreciation.
Related terms
- Carry TradeA carry trade borrows in a low-yielding currency and invests in a higher-yielding one, profiting from the interest rate differential as long as the exchange rate stays stable.
- Interest Rate DifferentialThe interest rate differential is the gap between interest rates of two countries, a core driver of currency carry trades, forward premiums and long-run exchange rate trends.
- Uncovered Interest Rate ParityUncovered interest rate parity theorises that a higher-yielding currency should depreciate over time by exactly the interest-rate gap, leaving no excess return from a carry trade once exchange-rate moves are accounted for.
- Fisher EffectThe Fisher effect states that the nominal interest rate equals the real interest rate plus expected inflation, so rates rise to compensate lenders for expected price increases.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.