Money, Banking & Finance Essay Example | Topics and Well Written Essays - 2000 words

The Fisher surmisal of Nominal Interest Rates and Inflation Rate - Essay ExampleAccording to the economist, interest is an tycoon of a communitys preference for a dollar of a present (income) over a dollar of future income (Library of political economy and Liberty, 2008). The label that he has put to his theory of interest ordain is the exasperation and opportunity. Fisher has postulated in this theory that interest rate results from an interface between two forces the metre preference that people have for capital at present and the principle of investment opportunity (Library of Economics and Liberty, 2008). Irving Fishers theory of interest establishes a link of token(a) interest rate (i) to the rate of inflation () and the hearty rate of interest (r). The rate which is derived after making an adjustment for the inflation is the unfeigned interest rate. This is the interest rate which the lenders should consider for lending their funds. The kindred that has been presented by Fisher between these terce interest rates is Thus, the above relationship states that if the rate of inflation increases by 1 percent, then the nominal interest rate increases by more than 1 percent. This means that there is a positive relationship between the rate of inflation and nominal interest rate (University of Missouri-Kansas City, 2010). In the next step of the analysis, the marrow of appraisees on the real rate of return will be taken into account. Let a demesne be considered with currency C. Then let it be the nominal risk-free rate of interest, rc be the real interest rate and c be the expected rate of inflation. Let to be the rate of tax on the interest income and r*c be the after-tax real rate of return. The after-tax rate of return is ic (1-to). Then, From the above expression, it can be explained that with the increase in the rate of inflation, the nominal interest rate too increases by a few proportion of the increase in inflation rate (Mulligan, 2002).