Interest Parity and the International Fisher Effect

The International Fisher Effect and Exchange Rates

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Q1a

When the interest parity condition holds and the domestic interest rate is greater than the foreign interest rate then the domestic currency is expected to decrease in value alongside the foreign currency thus a high inflation is expected in the country.

Q 1b

If the nominal interest rate is 2% in the United States and 5% in Canada one is expected to hold the United States bonds than the Canadian bonds since the high interest rate in Canada indicates expected inflation rate in the country to be high. Thus the Canadian dollars is expected to decrease in value against the United States dollar by 3% in regard to international Fisher effect.

E(e) = i$US -i $C

2% – 5% = -3%

Qc i

The market conditions may…