The International Fisher Effect is defined, as an estimated change in the current exchange rate between any two currencies is directly proportional to the difference between the two countries nominal interest rates at a particular time. The Fisher effect states that the real interest rate in a particular economy is independent of monetary variables. The generalized Fisher Effect states that the real interest rates should be same across the borders. The validity of generalized Fisher effect largely depends on the integration of the capital market. The capital markets of the developed countries are integrated in nature. It has been seen that in the underdeveloped countries the currency flow is restricted.

International Fisher Effect Formula:

E = [(i1-i2) / (1-i2)] – (i1-i2)

E = percentage change in exchange rate

i1 = interest rate of country A

i2 = interest rate of country B

An example using the formula above is if interest rate of country A is 10% and that of country B is 5% then the currency of Country B should appreciate roughly 5% compared to the currency of Country A.

The international Fisher Effect observation holds that a country with higher interest rate will also be inclined to have a higher inflation rate. The International Fisher Effect also estimates the future exchange rates based on the nominal interest rate relationships. The estimate of the spot exchange rate 12 months from now is calculated by multiplying the current spot exchange rate by the nominal annual U.S. interest rate then dividing it by the nominal annual British interest Rate.

References:

http://finance.mapsofworld.com/finance-theory/international-fisher-effect.html