The Fisher Effect, an economic theory proposed by economist Irving Fisher, describes the relationship between inflation, real interest rates, and nominal interest rates. The Fisher Effect states that the real interest rate, or the return on investment adjusting for inflation, is equal to the nominal interest rate minus the expected inflation rate. Investors and lenders use the Fisher Effect to assess their potential returns.

When the real interest rate is positive this means that the nominal rate of interest is higher than the rate of inflation. This allows the lender or investor to benefit from the return on investment while still beating inflation. A positive real interest rate is beneficial to lenders, as it allows them to access the purchasing power they are entitled to while avoiding losses due to inflation.

When the real interest rate is negative, it signals that the nominal rate of interest is lower than the rate of inflation. This means that the investor or lender would not be able to successfully beat inflation, as the rate of return does not meet or exceed the rate of inflation. This can be a problem for governments and individuals who may looking to benefit from a return on their investment.

In addition to the assessment of returns, the Fisher Effect has also been extended to the analysis of the money supply and international currency trading. In currency trading, the Fisher Effect states that when a currency is expected to experience inflation, traders must purchase a currency with a higher real interest rate in order to receive higher returns. Conversely, when expected inflation is low, traders look to invest in currencies with lower real interest rates in order to minimize losses.

Ultimately, the Fisher Effect is an essential part of economic analysis and the assessment of returns. By understanding the relationship between inflation, real interest rates, and nominal interest rates, investors and lenders can make informed decisions regarding their investments. Governments and international traders also leverage the Fisher Effect in order to make well informed decisions regarding the money supply and currency trading.