Dear Fellow CFA pupils, Just a question, hope to be enlightened here. I was reading on the International Fisher Relationship and came to a sentence that “real interest rates (nominal – inflation) would equalize across various countries as investors would buy into the currency which provides higher real returns” But I dun understand why that would happen?? If for eg. US has a higher real rate, ppl would buy USD n sell EUR for example…. USD would appreciate EUR would fall…. Import > Export…….USD would depreciate again………… why the higher real rate would fall and equalize?? Thanks for your explanation Thanks, Mexa
I will try this… The currency will appreciate due to higher real interest due to high demand for it, say the dollar per our example. People will want to invest in the US to take advantage of this high real interest rate. Eventually, there will be lot of dollars in market plus our exports will drop becoz the goods are now expensive and imports will be cheap, so an increase in imports and a decrease in exports, will push down, depreciate the dollar, and the real interest rate will drop, less demand for it…Real interest will equalize because this is one of the assumptions under Intl Fisher, that the real interest rates are the same in every country.
Ideally, in short run, Real interest rate will fluctuate but in long run real interest rate will equal across countries.