Distinguish between the International Fishers effect and Interest Rate Parity

Answer-

International fischer effect

international fischer effect states that the real interest rates are equal across countries.

The International Fisher Effect (IFE) is saying that future exchange rates will be determined by the relative interest rates in the two countries.

If country A's interest rate is 10% and country B's interest rate is 5%, country B's currency should appreciate roughly 5% compared to country A's currency. The notion behind the IFE is that a country with a higher interest rate will also tend to have a higher inflation rate.

Interest rate parity

Interest rate parity determines forward rates.when forecasting future spot rates then we use purchasing power parity (i.e. inflation rates).

Interest rate parity is when the difference between interest rates between two countries is equal to the difference in the spot and forward exchange rates.

Country A's currency is trading at par with Country B's currency, but the annual interest rate in Country A is 10 % and the interest rate in country B is 7 %. All other things being equal, it would make sense to borrow in the currency of B, convert it in the spot market to currency A and invest the proceeds in Country A.