ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -According to the Fisher equation, a 1 percent increase in the rate of inflation in turn causes a 1 percent increase in the nominal interest rate. The one-for-one relation between the inflation rate and the nominal interest rate is called the Fisher effect. (as measured by the CPI) in the United States since 1954.

Detailed explanation-2: -The precise formula is (1 + nominal interest rate) = (1 + real interest rate) x (1 + inflation rate). Since this formula can be difficult to calculate, a more commonly used formula is i ≈ r + where i is the nominal interest rate, r is the real interest rate and is the inflation rate.

Detailed explanation-3: -The Fisher equation is a concept in economics that describes the relationship between nominal and real interest rates under the effect of inflation. The equation states that the nominal interest rate is equal to the sum of the real interest rate plus inflation.

Detailed explanation-4: -The quantity theory of money, sometimes called “The Fisherian Theory” simply states that a change in price can be related to a change in the money supply. In simple terms, it states that the quantity of money available (money supply) in the economy and the price levels have the same growth rates in the long run.

Detailed explanation-5: -This is because inflation takes a ‘cut’ into the real value of the money being returned at the end of the loan period, so the real (adjusted for inflation) rate of interest is less than the nominal rate.