Irving Fisher

Economic Scientist, Economic and Social Reformer: An overview of the career and contributions of Irving Fisher (1867–1947) of Yale, an outstanding scientific economist whose reputation within the discipline of economics has recovered from his varied efforts at social reform (prohibition of alcohol, a new world map projection, dietary reform, a new calendar, eugenics) and being spectacularly wrong about the stock market in October 1929.

Revitalizing the Quantity Theory of Money: From the Fisher Relation to the Fisher Equation traces Fisher’s revitalization of the quantity theory of money from Appreciation and Interest (1896) to The Purchasing Power of Money (1911a, with Harry G. Brown), as Fisher upheld the quantity theory (with money neutral in the long run but not the short run) against populist bimetallists (who saw long-run real benefits from increasing the quantity of money, e.g. William Jennings Bryan) and their hard-money opponents (who denied that the price level was determined by the amount of money, e.g. J. L. Laughlin of the University of Chicago): the 1896 “Fisher relation” between interest rates in any two standards (real and nominal interest, uncovered interest arbitrage parity between two currencies, the expectations theory of the term structure of interest rates) and the 1911 equation of exchange or “Fisher equation” (MV + M′M′ = PT, first presented by Fisher with different notation in the Economic Journal in 1897, but drawing on an earlier single-velocity equation of exchange by Simon Newcomb, to whose memory Fisher 1911 was dedicated).

The Fisher Diagram and the Neoclassical Theory of Interest and Capital: After Fisher’s recovery from tuberculosis, he wrote developed the neoclassical theory of interest and capital in The Nature of Capital and Income (1906) and The Rate of Interest (1907) (later combined as The Theory of Interest, 1930), emphasizing the time pattern of expected income, the concept of present discounted value, and the role of the interest rate in equilibrating investment and saving, balancing impatience to spend with opportunity to earn interest, as shown in the “Fisher diagram” (the two-period consumption-smoothing diagram on Fisher [The Rate of Interest, Macmillan, New York, 1907, p. 409]). The Fisher diagram’s depiction of the terms of trade between consumption in two periods inspired fundamental diagrams in risk analysis (terms of trade between consumption in two states of the world) and international trade theory, while his identification of the present discounted value of expected lifetime income as the relevant budget constraint for consumption decisions (assuming perfect credit markets) led to the Friedman permanent-income and Modigliani-Ando-Brumberg life-cycle theories of consumption. Ironically, given the neoclassical emphasis of Fisher’s work on interest and capital, his 1907 demonstration of the possibility of multiple solutions for Boehm-Bawerk’s average period of production was a precursor of capital paradoxes that emerged fifty or sixty years later in the Cambridge capital theory controversies.

Fighting Money Illusion: The Fisher Ideal Index Number: If governments would not stabilize the price level, Fisher would combat The Money Illusion (the title of his 1928 book) by educating the public about how the purchasing power of money changed. Since governments did not then provide price indices, an Index Number Institute (located in the basement of Fisher’s home) would calculate a weekly wholesale price index, accompanied by a weekly newspaper article by Fisher on price changes, using the “Fisher ideal index” (the geometric mean of the Paasche and Laspeyres indices), the index number formula that Fisher’s Making of Index Numbers (1922) had shown came nearest to satisfying a set of seven statistical criteria chosen by Fisher and that in recent decades has come to be increasingly adopted by governments. Beyond education about price-level fluctuations, Fisher also pioneered indexation, persuading Rand Kardex to issue bonds indexed to Fisher’s price index.

Fisher’s Legacy in Economics: This chapter examines Fisher’s scientific legacy in economics. Fisher’s reputation suffered for decades from his stock market debacle and from the impact of Keynesian macroeconomics, but his importance as the outstanding American economic scientist of the first half of the twentieth century came to be recognized through the advocacy of, among others, Maurice Allais, Milton Friedman, Hyman Minsky, Paul Samuelson, and James Tobin (but not, e.g., Friedman’s coauthor Anna Jacobson Schwartz).