Fisher equation
Principles of Finance glossary · Valuation of Bonds & Stocks
Definition
The relationship linking nominal rate, real rate, and inflation: (1 + r_n) = (1 + r_r)(1 + π). The linear approximation r_n ≈ r_r + π holds when both are small.
Fisher equation in plain English
When someone quotes you an interest rate, part of it is just covering the fact that money loses buying power over time (inflation), and the rest is the actual extra you gain. The Fisher equation keeps those two pieces honest. Imagine a bank pays you 8% this year but prices also rose 5% — you didn't really get 8% richer; your true (real) gain is only about 3%. The exact formula is (1 + r_n) = (1 + r_r)(1 + π), where r_n is the quoted (nominal) rate, r_r is the real rate, and π is inflation; when the numbers are small you can just use the shortcut r_n ≈ r_r + π.
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