Money, interest rate and inflation:

The Fisher hypothesis is the proposition by Irving Fisher that the real interest rate is independent of monetary measures. The Fisher equation is

This means, the nominal interest rate (r_n) equals the real interest rate(r_r) plus expected inflation (ð^e ). Therefore, if ðe rises, so must r_n, if you assume r_r to be constant. This is known as the Fisher effect Fisher Effect: The one for one adjustment of the nominal interest rate to the expected inflation rate.

According to the principle of monetary neutrality due to  the classicals, an increase in the rate of money growth raises the rate of inflation but does not affect any real variable. An important application of this principle concerns the effect of money on interest rates. Interest rates are important variables for macroeconomists to understand because they link the economy of the present  and the economy of the future through their effects present and future consumption. Also there is a link between real and monetary sectors through interest rate as we in Keynesian perspective.

To understand the relationship between money, inflation and interest rates we need to understand nominal interest rate and real interest rate. The nominal interest rate is the interest rate you hear about at your bank. If you have a savings account, for instance, the nominal interest rate tells you how fast the number of rupees in your account will rise over time. The real interest rate corrects the nominal rate for the effect of inflation in order to tell you how fast the purchasing power of your savings account will rise over time. The real interst rate is the nominal interest rate minus the expected inflation rate.

Real interest rate = Nominal Interest Rate - Expected Inflation Rate

Or in other words

Nominal Interest Rate = Real interest Rate + Expected Inflation Rate

If inflation permanently rises from a constant level, let's say 4 percent a year, to a constant level, say 8 percent a year, that  currency's interest rate would eventually catch up with the higher inflation, rising by 4 points a year from their initial level. These changes leave the real return on that currency unchanged. The Fisher hypothesis argues that in the long-run, purely monetary  developments will have no effect on that country's relative prices.