What is the Fisher hypothesis? Does the experience of Latin American countries i

Question

What is the Fisher hypothesis? Does the experience of Latin American countries in the 1990s as indicated in Chapter 14 support or refute this hypothesis?

“If the Fisher hypothesis is true, then changes in the growth rate of the money stock translate one-for-one into changes in i.” Explain this effect and explain in words how the change in both money growth and expected inflation would affect 1) the IS curve, 2) the LM curve. Then explain how the neutrality of money concept changes when we introduce the concept of real interest rates and how the IS curve shifts when the Federal Reserve expands the money supply by buying bonds through Open Market Operations.

Explanation / Answer

Fisher hypothesis is also referrred to as Fisher effect. This proposition was developed by Irving Fisher. According to Fisher hypothesis, real interest rate is independent of monetary measures, specifically the expected inflation rate and nominal interest rate. Real interest rate is the nominal interest rate adjusted for the inflation effect on purchasing power of loan proceeds.

Real interest rate = Nominal rate - Expected rate of inflation

OR

Nominal rate = Real interest rate + Expected rate of inflation

Fisher effect is the important tool by which lenders can gauge whether or not they are making money on loan granted by them.

The experience of Latin American countries in the 1990s as indicated in Chapter 14 support refuted this hypothesis.

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