The parity conditions are equilibrium conditions that
establish linkage between financial prices in the absence
In economics, the fisher effects (sometimes called the Fisher effect) is the proposition by Irving
Fisher that the real interest rate is independent of monetary measures, specifically
the nominal interest rate and the expected inflation rate. The term "nominal interest rate" refers to
the actual interest rate giving the amount by which a number of dollars or other unit of currency
owed by a borrower to a lender grows over time; the term "real interest rate" refers to the amount by
which the purchasing power of those dollars grows over time—that is, the real interest rate is the
nominal interest rate adjusted for the effect of inflation on the purchasing power of the loan
The relation between the nominal and real rates is given by the Fisher equation, which is
This states that the real interest rate ( ) equals the nominal interest rate ( ) minus the
expected inflation rate ( ). Here all the rates are continuously compounded. For rates based
on simple interest, the Fisher equation takes the form
where is the simple nominal interest rate and is the simple real interest rate; this
equation is well approximated by using the simple rates in the previous equation provided all
three percentage rates are relatively small.
If the real rate is assumed, as per the Fisher hypothesis, to be constant, the nominal
rate must change point-for-point when rises or falls. Thus, the Fisher effect states
that there will be a one-for-one adjustment of the nominal interest rate to the expected
inflation rate. The implication of the conjectured constant real rate is that monetary events
such as monetary policy actions will have no effect on the real economy—for example, no
effect on real spending by consumers on consumer durables and by businesses on
machinery and equipment.
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. In this scenario, a rise in expected inflation results in
only a smaller rise in the nominal interest rate and thus a decline in the real interest rate
. It has also been contended that the Fisher hypothesis may break down in times of both
quantitative easing and financial sector recapitalisation. 
1. To describe the size of the foreign exchange market.
2. To list major participants in the foreign exchange market and their functions.
3. To distinguish between the spot and forward markets.
4. To explain how to read foreign-currency quotations as they appear in The Wall Street Journal.
5. To discuss five theories of exchange rate determination and their relationships: purchasing
power parity, Fisher Effect, International Fisher Effect, interest-rate parity, and forward rate as a
predictor of the future spot rate.
6. To explain different types of arbitrage and how to take advantage of covered interest arbitrage
The parity conditions are equilibrium conditions that establish linkage between financial prices in the
absence of arbitrage