Volume 10, Number 1, 2005
Federal Reserve Bank of Dallas
Irving Fisher: Origins of Modern Central
Bank Policy
| During
the first quarter of the 20th century, Irving
Fisher was one of America's most celebrated
economists. But sadly, most Americans today
have not heard of him. Even as his reputation
among the public faded with the years, his
reputation within the economics profession
has steadily risen. Fisher (no relation
to the undersigned, though I would like
to claim access to his gene pool) was a
pioneer in many theoretical and technical
areas of economics that today are the foundation
of central bank policy. One such achievement
was the creation of indexes to measure average
prices, the bedrock for all current monetary
policy. His was a storied and successful
career even if, by the time of his death,
Fisher's own finances and reputation as
an economic prognosticator lay in ruins.
We hope readers will find his life story
interesting as they learn more about this
pioneer of monetary economics.
| — |
Richard W. Fisher
President
Federal Reserve Bank of Dallas |
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Irving Fisher: Origins
of Modern Central Bank Policy
Irving Fisher was one of America’s
most celebrated economists. Although not widely remembered
outside of economics, within it he has increasingly
become considered a giant of the profession.
Fisher was born in 1867 in Saugerties,
New York, and died in New York City in 1947. He studied
at Yale University, where he was taught by such prominent
academics as William Graham Sumner, Josiah Willard Gibbs
and Arthur Twining Hadley. Sumner was the professor
who convinced Fisher to write his doctoral dissertation
on mathematical economics, a field then in its infancy.
Fisher received a B.A. in mathematics
in 1888, followed by a Ph.D. in economics in 1891. Although
he won every math prize contest he entered and the Yale
math faculty wanted him to major in mathematics as a
graduate student, during his senior year he became interested
in other subjects, including law, metaphysics and social
and political science.
His earliest economics research
culminated in his internationally acclaimed dissertation,
Mathematical Investigations in the Theory of Value
and Prices (1892). Fisher wrote this work under
the direction of the mathematics faculty because formal
economics doctorates typically were not offered in U.S.
universities at that time. In fact, Fisher wrote Yale’s
first.
Fisher had been well schooled
in the political economy of the day—primarily
the British tradition of Adam Smith, David Ricardo and
J. S. Mill—but ventured into neoclassical mathematical
economics, becoming one of its pioneers. Modern economics
was going through tremendous changes during Fisher’s
college years, and he helped lead it in the direction
that produced its current reliance on mathematics, general
equilibrium analysis and aggregate data sets for the
calculation of various price indexes. In this transformative
undertaking, he should be ranked along with Leon Walras,
Stanley Jevons and Francis Edgeworth.
After returning from a trip to
Europe in 1895, Fisher became an assistant professor
of political and social science at Yale (over the fierce
objections of the mathematics faculty, which wanted
Fisher for itself). He started teaching economics, rapidly
rising to the position of full professor in 1898. He
retired from Yale in 1935.
After his dissertation, more than
a decade passed before Fisher published another important
book on economics. Because of personal health concerns
during this period, he became fascinated with health-related
issues, explored various exercise and relaxation techniques,
wrote books about both and became almost a pure vegetarian.
When Fisher returned to economics,
one of his most notable contributions was his work on
the doctrine of dollar stability. He had always been
interested in the issue but did not put his ideas into
book form until 1911 with the publication of The
Purchasing Power of Money. The policy of price
stabilization, carried out today by central banks all
over the world, is mostly based on work done by Fisher
between 1895 and 1922, when his The Making of Index
Numbers was first published.
Before a price index can be stabilized
as a matter of monetary policy, it must be defined and
calculated. Fisher was one of the world’s first
experts on the calculation of index numbers. He began
the first weekly newspaper publication of a wholesale
price index in 1923.
In addition to helping originate
the idea of commodity money stabilization, Fisher’s
expertise ranged from the general equilibrium theorizing
of his dissertation to the emerging study of econometrics.
He was a cofounder of the American Econometrics Society
(1931) and was its first president (1932). He even published
definitive works in accounting theory and practice.
His theoretical work touches on almost every major macroeconomic
issue and is still regularly consulted and cited, not
only by historians of economic thought, but also by
practicing economists. That, in itself, sets him apart
from most of his contemporaries.
A key area of interest for Fisher
was the quantity theory of money, and his work was a
forerunner of what macroeconomists today call monetarism.
[1] Fisher attempted to take the classical school’s
equation of exchange (MV = PT), which is simply
a mathematical truism, and convert this equation into
a general theory of prices and, therefore, of the price
level. He did this by allowing for transition periods
when the flow of the money supply is changed (thus breaking
the equality of the equation during the transition period).
He laid out his ideas thoroughly
in The Purchasing Power of Money. The book
is also a long plea for Fisher’s views about how
a commodity money (in this case, gold) can be stabilized
in international trade situations. He anticipated much
of what today we call “monetary rules.”
His approach was to make the U.S. dollar one of constant
purchasing power and not one of a constant amount (weight)
of gold or anything else.
The idea he promoted in his book,
and continued to advocate for the rest of his life,
came to be called the compensated dollar. He argued
for altering the commodity price of gold inversely with
movements in a designated price index to stabilize its
real purchasing power. He also anticipated—by
over 40 years—A. W. Phillips’ famous curve
with its trade-off between inflation and unemployment.
In addition to his other endeavors,
Fisher was an inventor and entrepreneur. He created
and patented an index card file system (known today
as the Rolodex) that led him to start the Index Visible
Company, which merged with Kardex Rand in 1925 and later
became Remington Rand. The company made Fisher very
wealthy. Yet for all his knowledge of economic theory
and markets, Fisher suffered huge declines in his personal
fortune and his professional reputation in the 1929
stock market crash and the Great Depression, eventually
leaving an estate so small it wasn’t even taxed.
His son estimated his monetary
losses in this period to have been as much as $10 million.
He continued buying stock well past the time it was
prudent to do so. When he was finally broke, Yale University
had to buy his house and rent it back to him to keep
him from being evicted. His sunny predictions of a “new
era” with continuing prosperity, even after the
1929 crash, lowered his reputation among economists
as well as the general public.
Despite falling from the rank
of America’s best-known economist into obscurity
for several decades, Fisher’s reputation has since
risen steadily as economists rediscover the path-breaking
work he did on so many important topics. Fisher wrote
29 books, 14 of which are about economics. Joseph Schumpeter’s
1948 memorial article sums up well Fisher’s many
contributions and his long-term place in the history
of economics:
| In his scientific work, he
stood almost alone.... There are no Fisherians in
the sense in which there have been Ricardians or
Marshallians and in which there are Keynesians....
But those pillars and arches [of Fisher’s
theoretical temple] will stand by themselves. They
will be visible long after the sands will have smothered
much that commands the scene of today.[2] |
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Robert L. Formaini
Senior Economist |
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| Notes
-
For accounts of this theory by other
famous economists, see “Knut Wicksell:
The Birth of Modern Monetary Policy,”
by Robert L. Formaini, Federal Reserve
Bank of Dallas Economic Insights,
vol. 9, no. 1, and “Milton Friedman:
Economist as Public Intellectual,”
by Robert L. Formaini, Federal Reserve
Bank of Dallas Economic Insights,
vol. 7, no.
-
Schumpeter (1969), 237–38.
Sources and Suggested
Reading
Blaug, Mark (1986),
Great Economists Before Keynes (New
York: Cambridge University Press).
Fisher, I. N. (1956),
My Father, Irving Fisher (New York:
Comet Press Books).
Fisher, Irving (1906),
The Nature of Capital and Income
(New York: MacMillan).
———
(1928), The Money Illusion (New
York: Adelphi Company).
———
(1936), 100% Money (New York: Adelphi
Company).
———
(1965), The Theory of Interest
(New York: Augustus M. Kelley), orig. pub.
1930.
Humphrey, Thomas (1997),
“Fisher and Wicksell on the Quantity
Theory,” Federal Reserve Bank of Richmond
Quarterly Review, 83 (Fall).
Laidler, David (1991),
The Golden Age of the Quantity Theory
(Princeton, N.J.: Princeton University Press).
Schumpeter, Joseph
A. (1969), “Irving Fisher,”
in Ten Great Economists from Marx to
Keynes (New York: Oxford University
Press), 222–38.
Tobin, James (1987),
“Irving Fisher,” in The
New Palgrave: A Dictionary of Economics,
vol. 2, ed. John Eatwell, Murray Milgate
and Peter Newman (New York: Stockton Press),
369–76. |
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A Modest
Agenda
In his book 100%
Money, Fisher begins by setting himself
the following small task:
| Designed to keep
checking banks 100% liquid; to prevent
inflation and deflation; largely to
cure or prevent depressions; and to
wipe out much of the National Debt. |
In this book, produced
during the middle of the Great Depression,
Fisher endorsed the so-called Chicago Plan
put forward by leading economists at the
University of Chicago. The plan included
100 percent bank reserves, and Fisher endorsed
it because he believed the system in place
before 1935 had been far too unstable. He
writes here about the 1920s but could just
as well be predicting the late 1990s:
The over-indebtedness
hitherto presupposed must have had
its starters. Over-indebtedness may
be started by many causes, of which
the most common appears to be new
opportunities to invest at a big prospective
profit, as compared with ordinary
profits and interest. Such new opportunities
occur through new inventions, new
industries, development of new resources,
opening of new lands or new markets.
When the rate of profit is expected
to be far greater than the rate of
interest, we have the chief cause
of over-borrowing. When an investor
thinks he can make over 100 per cent
per annum by borrowing at 6 per cent,
he will be tempted to borrow, and
to invest or speculate with borrowed
money. This was a prime cause leading
to the over-indebtedness of 1929.
Inventions and technological improvements
created wonderful investment opportunities,
and so caused big debts....
When the starter
consists of new opportunities to make
unusually profitable investments,
the bubble of debt, especially bank
loans, tends to be blown bigger and
faster than when the starter is some
great misfortune, like an earthquake
causing merely non-productive debts....
The public psychology
of going into debt for gain passes
through at least four more or less
distinct phases: (a) the lure of big
prospective profits in the form of
dividends, i.e. income in
the future; (b) the hope of selling
at a profit, and realizing a capital
gain in the immediate future; (c)
the vogue of reckless promotions,
taking advantage of the habituation
of the public to great expectations;
(d) the development of downright fraud,
imposing on a public which had grown
credulous and gullible.
When it is too
late, the dupes discover scandals
like the Hatry and Kreuger scandals.
At least one book has been written
to prove that crises are due to frauds
of clever promoters. But these frauds
could seldom, if ever, have become
so great without the original starters
of genuine opportunities to invest
lucratively. There is probably always
a very real basis for the “new
era” psychology before it runs
away with its victims. |
—100%
Money, 130–32 (original emphasis) |
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Is Gold
Stable?
Our fixed-weight dollar
is as poor a substitute for a really stable
dollar as would be a fixed weight of copper,
a fixed yardage of carpet, or a fixed number
of eggs. If we were to define a dollar as
a dozen eggs, thenceforth the price of eggs
would necessarily and always be a dollar
a dozen. Nevertheless, the supply and demand
of eggs would keep on working. For instance,
if the hens failed to lay, the price of
eggs would not rise but the price of almost
everything else would fall. One egg would
buy more than before. Yet, because of Money
Illusion, we would not ever suspect the
hens of causing low prices and hard times.
In what sense, then, should a dollar be
fixed if not in weight. Evidently, in buying
power.
—The
Money Illusion, 17 |
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Can Capital
Be Measured?
Such a collection
(capital machines) of wealth is, however,
heterogeneous; it cannot be expressed in
a single sum. We can inventory the separate
items, but we cannot add them together.
They may, however, be reduced to a homogeneous
mass by considering, not their kinds and
quantities, but their values. And this value
of any stock of wealth is also called “capital.”
To distinguish these two senses of capital,
we call a stock, store or accumulation of
existing instruments of wealth, each instrument
being measured in its own unit, capital-instruments,
or capital-wealth, and we call the value
of this stock, when all articles are measured
in a common unit, capital-value.
—The
Nature of Capital and Income, 66 (original
emphasis) |
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Ought the
Gold Standard Be “Automatic”?
As to the idea that
the government should make the gold standard
“automatic” and unassisted by
any legislative action, even if that implies
(as it certainly does) unstable money, the
reply is that there is no function of government
more obviously proper than to keep stable
the units by which we measure. We have a
Bureau of Standards which fixes the units
of length, weight, volume, electricity,
and of every other unit employed in commerce,
except the most important and universally
used unit of all, the unit of value. Our
Federal Constitution authorizes Congress
to “coin money and regulate the value
thereof, and of foreign coin, and fix the
standard of weights and measures.”
There is a popular
fiction that our price level and gold standard
ought to be left to the “natural”
play of supply and demand and not subjected
to “arbitrary” interference.
Of course every unit of measure is “arbitrary.”
There is no “natural” yard.
The gold dollar is already “arbitrary”
at 23.22 grains. In fact it is unnaturally
arbitrary to fix it in weight;
for this interferes with the play of supply
and demand on the price of gold. This price,
on the plea of “naturalness,”
certainly ought to be as free to fluctuate
as the price of silver, instead of being
tied to the fixed figure $20.67 per ounce.
The idea that the
gold standard today is, or can be, “automatic”
is wrong. As we have seen, gold is now far
more influenced by banking policy than by
its use in the arts for dentistry, gilding
picture frames or making gold watches, rings
and jewelry. Such use is trivial in comparison
with its importance in finance. As Reginald
McKenna [1863–1943, British politician
and banker, chancellor of the exchequer,
1915–16] has said, the world now has
a “dollar standard” fixed by
credit control rather than a gold standard
fixed by gold bullion as such.... We already
have human discretion, operating if not
to control, at least to influence, the price
level; we no longer have an automatic gold
standard. And we ought to be profoundly
thankful!
Only by the exercise
of discretion, duly safeguarded, can we
really expect some day fully to stabilize
the dollar.
—The
Money Illusion, 156–58 (original
emphasis) |
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A Great
Economist—but a Failure as a Social
Reformer
As a social reformer,
Irving Fisher was a failure. He opposed
the federal income tax, but the 16th Amendment
created one. He was in favor of the Prohibition
Amendment, but that was eventually repealed.
He passionately advocated monetary and tax
policies that were never adopted. His association
with “healthy food” companies
wound up with him attaching his name to
such products as sugar-coated breakfast
cereals made by Post and Kellogg. With President
Woodrow Wilson, he strongly supported creation
of a League of Nations after World War I.
Retrospectively, perhaps
the worst endeavor he supported was the
American eugenics movement, serving as president
of its national association from 1922 to
1926. Like other notables who grew up during
the Progressive Era, Fisher became convinced
that a scientific approach to producing
better human beings was not just possible,
but desirable. History has judged this undertaking
in a negative light. But these ideas were
popular at the time, considered by many
to be cutting edge science. Many major news
organizations in the United States were
enthusiastic supporters, even editorializing
in support of infanticide as a legitimate
means of carrying out the eugenics program.
In the late 1930s, the U.S. Supreme Court
in a famous opinion authored by Oliver Wendell
Holmes legally endorsed forced sterilization
as another weapon to be used against the
“genetically undesirable.”
But in spite of all
this, Fisher’s immersion in social
reforms of large scope is curious given
his own youthful insights on this very subject.
In a letter to a Yale colleague in 1895,
Fisher demonstrated great wisdom on the
topic of large reform movements and social
reformers generally:
| Concerning social
reform, I feel that the effort of philanthropists
to apply therapeutics too soon is more
likely to lead to evil than good. The
very best the exhorter can do is to
work against the “something
must be done” spirit, and beg
us to wait patiently until we know enough
to base action upon and meantime confine
philanthropic endeavor to the narrow
limits in which it has been proved successful—chiefly
education.... There is so much specific
reform at hand to be done—in city
government, suppression of vice, education—that
the hard workers of humanity need not
and ought not talk, until “little”
things are done, on broad schemes for
“society.” |
—My
Father, Irving Fisher, 71 (original
emphasis)
Later in his life,
Fisher clearly did not take the thoughtful
advice that he dispensed to others when
younger. |
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| About
Economic Insights
Economic Insights
is a publication of the Federal Reserve
Bank of Dallas. The views expressed are
those of the authors and should not be attributed
to the Federal Reserve System.
Please address all
correspondence to
Economic
Insights
Public Affairs Department
Federal Reserve Bank of Dallas
P.O. Box 655906
Dallas, TX 75265-5906 |
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