What significance does the International Fisher Effect play in today’s world, I ask myself. How does it affect me? The International fisher effect is the theory that states that expected exchange in the current exchange rates between any two countries is equivalent to the difference between the two countries nominal interest rates for that time according to the definition found on Investopedia. I live in the United States where the interest rate is at .25%, and China nominal exchange rate for December is 5.31% according to Trading Economics. So if I apply the definition the exchange between China and the United states should yield a difference of 5.06%. So the US should be appreciating by 5.06% with respects to China but I find that this is not the case. According to Investopedia the country with the highest interest rate will also have the higher inflation rate. China’s inflation rate is (-0.50), and the US inflation rate is (-.020) according to Trading Economics. So it is not always true that the country with the highest interest rate will always have the higher inflation rate. Based on the International Fisher Effect, China should have the higher inflation rate but it does not according to the data. The US has the higher inflation rate by a difference of (-0.30). Is this a result of the US Fed artificially maintaining the US exchange rate near zero.

For all of 2009 the US interest rate has been held at .25% how does this affect me? It affects me by limiting my purchasing power when buying goods or services abroad. Instead of appreciating by 5.06% with respects to China we are maintaining our currency exchange with China between 6.82-.83Y to the USD according to X-rates.com. Well it affects me because the Chinese RMB will not lose value against the US dollar by depreciating. So goods made in China will continue to be a constant exchange rate and not making US good more attractive. The trade deficit with China will continue until market forces are allowed to work with respects to interest rates, and inflation between two nations. US goods today should be more competitive with China if we apply the International Fisher Effect, but what we can determine here is that government control of interest rates will not allow this IFE to fully function. So today the International Fisher Affect between the US and China is not working according to the economic theory.

Works Cited

1. Investopedia (http://www.investopedia.com/terms/i/ife.asp).

2. Trading Economics http://www.tradingeconomics.com/Economics/Interest-Rate.aspx?Symbol=

3. X-rates.com

4. Financial Times http://www.ft.com/home/us