Home >Opinion >Online-views >The neglected part of Fisher

The three greatest economists of the last century— Irving Fisher, Milton Friedman and John Maynard Keynes—wrote extensively for decades on macroeconomic outcomes—in particular, on the Great Depression. The most famous of them, Keynes, out of fashion for long, is now back to the forefront. Many leading economists (Paul Krugman, Nouriel Roubini, and surprisingly even Raghuram Rajan, who has been advocating financial deregulation for India in the University of Chicago, free-market tradition) are on record as saying that Keynes is their main intellectual hero.

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However, of the three cited above, in my opinion, Fisher’s timely analysis of the Depression stands head and shoulders above that of Keynes’ income-expenditure multiplier approach of his General Theory. Some of Friedman’s Great Depression analysis and conclusions derive from Fisher. Neglect of Fisher’s other work is also a huge taint on mainstream macroeconomists. His Appreciation and Interest (1896) provides the first thorough exposition of his well-known Fisher equation for interest rates and the related “monetarist paradox", tracing it back to an anonymous Boston pamphlet written in 1740. The term “money illusion", associated with Keynes and wage-price rigidities was propounded by him. The subject Finance is largely based on the time value of money concept i.e. the present value discounting that he explained.

After graduating from Yale, Fisher (1867-1947) taught Mathematics and worked in related areas there before moving to economics at Yale itself. A phenomenally prolific author and product inventor, he wrote numerous pamphlets and newspaper articles on a range of subjects, such as “humanizing industry", now called corporate social responsibility. He nearly died from tuberculosis early in life. This made him a health fanatic, preaching about lifestyle with a missionary zeal. Two pamphlets were titled “I don’t Drink-Why" and “Seductive Wiles of MY lady Nicotine".

Fisher’s 1933 article (The Debt-Deflation Theory of Great Depressions, first enunciated in his lectures in 1931) combines vital evidence with clarity. From Japan’s economic malaise of the 1990s onwards to collapsing real estate prices in India now, the debt deflation theory has great relevance.

Krugman made a famous 1998 recommendation to the Bank of Japan to overcome its slump—announce an inflation target and pursue it aggressively. This was presented by him and is mostly seen as a way out of Keynesian’ liquidity trap at zero interest rates. Failure to mention Fisher in this context is like enacting Hamlet without the Prince of Denmark.

From December 1932 onwards, Fisher advocated a “stamped scrip" plan for reflation. Strongly supporting the then unorthodox reflation plan of newly inaugurated President Franklin D. Roosevelt, Fisher wrote: “Debt and deflation, which has wrought havoc up to March 4, 1933 were then stronger than ever and if left alone would have wreaked even greater wreckage than ever after March 4." Further, hitting out at simple laissez-faire dogma he also stated that “had no artificial respiration been applied…we would have seen general bankruptcies of the mortgage companies, savings banks, life insurance companies…"

While small recessions can be self correcting, depressions are not. The Hayekian view is that business cycles are due to over-investment relative to consumption—markets should be allowed to rectify the imbalances. Leaving aside the long run moral hazard consequences of stimulus plans, which one should always be concerned about, right now this Hayekian view is hardly pragmatic, sound economics. It mixes up what may be the catalyst with the subsequent reaction—what in business cycle literature are called impulse and propagation mechanisms, respectively.

The debt-deflation theory is best summed up in Fisher’s own words, “The very effort of individuals to lessen their burden of debt increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed…The more the debtors pay, the more they owe (1933)." It follows that the steel magnate Andrew Mellon’s advice then to liquidate one’s way out of the Depression is wrong. Continuing, he wrote that “the more the economic boat tips, the more it tends to tip".

Fisher’s view in the last sentence above that the macroeconomy is self-correcting for small but not large shocks, is the basis for Axel Leijonhufvud’s later ‘corridor hypothesis’. (Leijonhufvud, my thesis committee head had mentioned that he had planned to do his thesis on debt-deflation. Instead, among other things, he critiqued the textbook Keynesian IS/LM model, in his famous 1968 book On Keynesian Economics and the Economics of Keynes).

The penetrating, timely analysis of Fisher is finally getting wider credit, as in The Economist recently (14 February issue). Much of current US Federal Reserve chairman Ben Bernanke’s solid empirical research, on credit freezing up during the Depression due to collapsing asset values, and the Bernanke-Gertler “financial accelerator" model builds upon Fisher’s 1933 paper. Hyman Minksy has also outlined processes of financial sector instability along Fisherian lines.

However, in my opinion, where Bernanke has gone egregiously astray is in accepting only the second phase of Fisher’s recommendations—the post-collapse commitment to being irresponsible and reflating. Instead, one should look at the whole cycle. After discussing various theories to explain business cycles (over-investment, over-saving, overconfidence, etc.,), Fisher concludes that there are two dominant factors, “...namely, overindebtedness to begin with, and deflation following soon after." (Emphasis in the original). He stated that “easy money is the great cause of overborrowing".

If Bernanke had fully accepted Fisher’s world view, then he should have been paranoid about growing indebtedness and rising asset prices, each feeding upon the other, from the late 1990s onwards. From that time on, he should have called for raising interest rates to tackle the asset bubble and rising debt. Instead Bernanke explicitly recommended not to try to tackle asset bubbles. He suggested, along with Frederic Mishkin and Adam Posen in 2000 in a prominent Wall Street Journal article, that the Fed legislate and follow a policy of Direct Inflation Targeting (of a final consumer price index), as some other central banks had done. And in his actual decisions as Fed governor from 2002 onwards, Bernanke has been a reliable accomplice to Alan Greenspan in keeping interest rates low, thus encouraging overborrowing. His suggestion that the Fed buy long term government bonds to avert deflation, if needed, (but not sell them to avoid overheating) extended Greenspan’s ‘equity put’ to the bond market. The world economy is now kaput.

Vivek Moorthy is a professor of economics at IIM Bangalore. Comment at

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