Using the IFE to Predict Exchange Rate Movements
Apply the Fisher Effect to Derive Expected Inflation per Country
The first step is to derive the expected inflation rates of the two countries based on the Fisher effect. The Fisher effect suggests that nominal interest rates of two countries differ because of the difference in expected inflation between the two countries.
Rely on PPP to Estimate the Exchange Rate Movement
The second step of the international Fisher effect is to apply the theory of PPP to determine how the exchange rate would change in response to those expected inflation rates of the two countries.