Question

If inflation in the United States is 4% per year and in the United Kingdom it is 8% per year, and interest rate in the United Kingdom is 6%, then the Fisher effect predicts that the interest rate in the United States is:

Answer 1

Answer:

The correct answer is 2%.

Explanation:

The fisher effect describes the relationship between interest rates in two countries and the exchange rate of their currencies. In this example, it is said that the difference between the interest rate vs the inflation of the united group shows a difference of 2% that the United States is also expected to experience with an annual inflation rate of 4%.

Answer 2

Answer:

2%

Explanation:

Given:

• Inflation in the United States is 4%
• Inflation in the UK is 8%
• Interest rate in the United Kingdom is 6%

As we know:

Nominal interest rate = Inflation rate + Real interest rate

Let analyse the nominal interest rate in the UK

<=> Real interest rate = 6% - 8% =- 2%

Then the Fisher effect predicts that the interest rate in the United States when applying the global interest rate is:

= Nominal interest rate = Inflation rate + Real interest rate

= -2% + 4%

= 2%