Nominal and real interest rates are often viewed from the perspectives of the intuitively appealing Fisher relationship and pure expectations hypothesis. These complementary relationships relate real or nominal long-term interest rates to expected future short-term interest rates and relate short- or long-term nominal interest rates to the ex ante real interest rate and the expected inflation rate. Consumption-based bond pricing theory implies that if investors are risk-averse then interest rates deviate from the Fisher relationship and the expectations hypothesis, and the deviations are described by forward premiums and inflation-risk premiums. We provide a detailed introduction to the theory, using the two Fisherian interest rate decompositions and the corresponding premiums as the organizing framework.
Amanda L. Kramer
To receive a notification by email when Economic Quarterly is posted online or to order single copies of past issues, click on the links below (published online only since 2012).