# Fisher Effect vs Quantity Theory of Money and how an increase in the money supply lowers interest rates?

I was under the impression that in the long run, a larger money supply resulted in lower interest rates. According to the Quantity Theory of Money, see below figure, an increase in the money supply -> An increase in price levels.

Increasing price levels == increasing inflation rate.

Fisher Effect:

According to the Fisher Effect:

Nominal Interest Rates = Real Interest Rates + Inflation


Changes in the money supply should not affect the Real Interest Rate in the long term therefore there is a 1 for 1 increase in Nominal Interest Rates and Inflation in order to maintain the equation.

The Chart suggests that an Increase in money supply => Higher prices == Inflation, which i believed meant lower interest rates.

But the Fisher Effect seems to be suggesting the opposite, hence my confusion.

I would appreciate any help in clarifying this, thanks in advance.

• Since the nominal interest rate is determined as the sum of the real interest rate plus inflation, how did you arrive at the impression that inflation decreases the nominal interest rate? – Alecos Papadopoulos Mar 28 '17 at 19:01
• @AlecosPapadopoulos Thanks for replying. Based on the figure in the original question, the increase in money supply shifts the equilibrium point from A to B, which according to the Axis on the right, increases prices. In order to increase the money supply, i thought the interest rates had to decrease. – Hans Rudel Mar 28 '17 at 19:56
• The interest rates "had to" decrease? Why? – Alecos Papadopoulos Mar 28 '17 at 20:22
• – Hans Rudel Mar 28 '17 at 21:16
• I may have misunderstood something though, i just bought a txtbook and have been reading through it as i never studied economics at School/uni and regret not having a better understanding of it. – Hans Rudel Mar 28 '17 at 21:17

Both the picture posted by the OP, as well as an online tutorial the OP linked to, examine shifts in the supply of money, leaving the money demand unaffected.

(I also note that the picture looks at money demand more as "liquidity demand", while the on-line tutorial examines "demand for borrowing funds")

The Fisher Hypothesis first of all relates to expected inflation, and compacts movements in both the supply curve as well as in the demand curve, as a result of inflationary expectations.

• During Quantitative Easing the Federal Reserve Banks wanted to keep interest rates low. But to try put a floor under nominal interest rates, the Fed voluntarily paid interest on excess reserves (IOER): $0.25\%$ from 2009 to 2015, and $1\%$ now that interest rates are rising, so commercial banks would not be keen to lend at lower rates – Henry Mar 29 '17 at 20:52