It is named after the economist Irving Fisher, who first observed and explained this relationship.
Fisher proposed that the real interest rate is independent of monetary measures (known as the Fisher hypothesis), therefore, the nominal interest rate will adjust to accommodate any changes in expected inflation.
[1] The nominal interest rate is the accounting interest rate – the percentage by which the amount of dollars (or other currency) owed by a borrower to a lender grows over time, while the real interest rate is the percentage by which the real purchasing power of the loan grows over time.
In other words, the real interest rate is the nominal interest rate adjusted for the effect of inflation on the purchasing power of the outstanding loan.
The relation between nominal and real interest rates, and inflation, is approximately given by the Fisher equation: The equation states that the real interest rate (
The accurate equation can be expressed using periodic compounding as: If the real rate
Some contrary models assert that, for example, a rise in expected inflation would increase current real spending contingent on any nominal rate and hence increase income, limiting the rise in the nominal interest rate that would be necessary to re-equilibrate money demand with money supply at any time.
results in only a smaller rise in the nominal interest rate
It has also been contended that the Fisher hypothesis may break down in times of both quantitative easing and financial sector recapitalisation.