IDEAS home Printed from https://ideas.repec.org/p/ngi/dpaper/07-05.html
   My bibliography  Save this paper

DEVOLUTION OF THE FISHER EQUATION: Rational Appreciation to Money Illusion

Author

Listed:
  • James R. Rhodes

    (National Graduate Institute for Policy Studies)

Abstract

In Appreciation and Interest Irving Fisher (1896) derived an equation connecting interest rates in any two standards of value. The original Fisher equation (OFE, 1896) was expressed in terms of the expected appreciation of money (the real return on money) whereas the ubiquitous conventional Fisher equation (CFE, 1930) uses expected inflation. Since the OFE is based on the value of money (1/P) it is not subject to standard criticisms of irrationality leveled against the CFE. Fisher’s puzzling substitution of lagged inflation for expected money appreciation in 1930 is resolved by taking into account his theory of “money illusion.”

Suggested Citation

  • James R. Rhodes, 2006. "DEVOLUTION OF THE FISHER EQUATION: Rational Appreciation to Money Illusion," GRIPS Discussion Papers 07-05, National Graduate Institute for Policy Studies, revised Sep 2007.
    • Handle: RePEc:ngi:dpaper:07-05
    as

    Download full text from publisher

    File URL: https://grips.repo.nii.ac.jp/?action=repository_action_common_download&item_id=975&item_no=1&attribute_id=20&file_no=1
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 28-43, National Bureau of Economic Research, Inc.
    2. Evans, Martin D D & Lewis, Karen K, 1995. "Do Expected Shifts in Inflation Affect Estimates of the Long-Run Fisher Relation?," Journal of Finance, American Finance Association, vol. 50(1), pages 225-253, March.
    3. Rose, Andrew Kenan, 1988. " Is the Real Interest Rate Stable?," Journal of Finance, American Finance Association, vol. 43(5), pages 1095-1112, December.
    4. Robert W. Dimand, 1999. "Irving Fisher and the Fisher Relation: Setting the Record Straight," Canadian Journal of Economics, Canadian Economics Association, vol. 32(3), pages 744-750, May.
    5. John H. Crockett, Jr., 1980. "Irving Fisher on the Financial Economics of Uncertainty," History of Political Economy, Duke University Press, vol. 12(1), pages 65-82, Spring.
    6. Shome, Dilip K & Smith, Stephen D & Pinkerton, John M, 1988. " The Purchasing Power of Money and Nominal Interest Rates: A Re-examination," Journal of Finance, American Finance Association, vol. 43(5), pages 1113-1125, December.
    7. Wallace, Myles S & Warner, John T, 1993. "The Fisher Effect and the Term Structure of Interest Rates: Tests of Cointegration," The Review of Economics and Statistics, MIT Press, vol. 75(2), pages 320-324, May.
    8. Mitchell, Douglas W, 1985. "Expected Inflation and Interest Rates in a Multi-asset Model: A Note," Journal of Finance, American Finance Association, vol. 40(2), pages 595-599, June.
    9. Choudhry, Taufiq & Placone, Dennis & Wallace, Myles, 1991. "Changes in the fisher effect in the 1980s: Evidence from various models," Journal of Economics and Business, Elsevier, vol. 43(1), pages 59-68, February.
    10. Francisco Carneiro & Jose Angelo & C. A. Divino & Carlos Rocha, 2002. "Revisiting the Fisher hypothesis for the cases of Argentina, Brazil and Mexico," Applied Economics Letters, Taylor & Francis Journals, vol. 9(2), pages 95-98.
    11. Chan, Louis K C, 1994. "Consumption, Inflation Risk, and Real Interest Rates: An Empirical Analysis," The Journal of Business, University of Chicago Press, vol. 67(1), pages 69-96, January.
    12. Pierre-Daniel G. Sarte, 1998. "Fisher's equation and the inflation risk premium in a simple endowment economy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 53-72.
    13. Ioannis Karatzas & Martin Shubik & William D. Sudderth & John Geanakoplos, 2003. "The Harmonic Fisher Equation and the Inflationary Bias of Real Uncertainty," Cowles Foundation Discussion Papers 1424, Cowles Foundation for Research in Economics, Yale University.
    14. Frederic S. Mishkin & John Simon, 1995. "An Empirical Examination of the Fisher Effect in Australia," The Economic Record, The Economic Society of Australia, vol. 71(3), pages 217-229, September.
    15. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-276, June.
    16. Crowder, William J & Hoffman, Dennis L, 1996. "The Long-Run Relationship between Nominal Interest Rates and Inflation: The Fisher Equation Revisited," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(1), pages 102-118, February.
    17. Lucas, Robert E, Jr, 1980. "Two Illustrations of the Quantity Theory of Money," American Economic Review, American Economic Association, vol. 70(5), pages 1005-1014, December.
    18. Ahmed, Shaghil & Rogers, John H., 2000. "Inflation and the great ratios: Long term evidence from the U.S," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 3-35, February.
    19. Ernst Fehr & Jean-Robert Tyran, 2001. "Does Money Illusion Matter?," American Economic Review, American Economic Association, vol. 91(5), pages 1239-1262, December.
    20. Tanzi, Vito, 1980. "Inflationary Expectations, Economic Activity, Taxes, and Interest Rates," American Economic Review, American Economic Association, vol. 70(1), pages 12-21, March.
    21. Fisher, Irving, 1907. "The Rate of Interest," History of Economic Thought Books, McMaster University Archive for the History of Economic Thought, number fisher1907.
    22. Fama, Eugene F, 1976. "Inflation Uncertainty and Expected Returns on Treasury Bills," Journal of Political Economy, University of Chicago Press, vol. 84(3), pages 427-448, June.
    23. Wassily W. Leontief, 1936. "The Fundamental Assumption of Mr. Keynes' Monetary Theory of Unemployment," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 51(1), pages 192-197.
    24. Kandel, Shmuel & Ofer, Aharon R & Sarig, Oded, 1996. "Real Interest Rates and Inflation: An Ex-Ante Empirical Analysis," Journal of Finance, American Finance Association, vol. 51(1), pages 205-225, March.
    25. Hutchison, Michael M & Keeley, Michael C, 1989. "Estimating the Fisher Effect and the Stochastic Money Growth Process," Economic Inquiry, Western Economic Association International, vol. 27(2), pages 219-239, April.
    26. Nelson, Charles R & Schwert, G William, 1977. "Short-Term Interest Rates as Predictors of Inflation: On Testing the Hypothesis That the Real Rate of Interest is Constant," American Economic Review, American Economic Association, vol. 67(3), pages 478-486, June.
    27. Barsky, Robert B., 1987. "The Fisher hypothesis and the forecastability and persistence of inflation," Journal of Monetary Economics, Elsevier, vol. 19(1), pages 3-24, January.
    28. Robert W. Dimand & John Geanakoplos, 2005. "Celebrating Irving Fisher: The Legacy of a Great Economist," American Journal of Economics and Sociology, Wiley Blackwell, vol. 64(1), pages 3-18, January.
    29. William J. Crowder & Mark E. Wohar, 1999. "Are Tax Effects Important in the Long‐Run Fisher Relationship? Evidence from the Municipal Bond Market," Journal of Finance, American Finance Association, vol. 54(1), pages 307-317, February.
    30. Benninga, Simon & Protopapadakis, Aris, 1983. "Real and Nominal Interest Rates under Uncertainty: The Fisher Theorem and the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 91(5), pages 856-867, October.
    31. Peter N. Ireland, 1996. "Long-term interest rates and inflation: a Fisherian approach," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 21-36.
    32. Hansson, Ingemar & Stuart, Charles, 1986. "The Fisher Hypothesis and International Capital Markets," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1330-1337, December.
    33. Klein, Benjamin, 1975. "Our New Monetary Standard: The Measurement and Effects of Price Uncertainty, 1880-1973," Economic Inquiry, Western Economic Association International, vol. 13(4), pages 461-484, December.
    34. Jeung-Lak Lee & Carolyn Clark & Sung Ahn, 1998. "Long- and short-run Fisher effects: new tests and new results," Applied Economics, Taylor & Francis Journals, vol. 30(1), pages 113-124.
    35. Benjamin Klein, 1975. "Our New Monetary Standard: The Measurement and Effects of Price Uncertainty," UCLA Economics Working Papers 062, UCLA Department of Economics.
    36. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71, pages 280-280.
    37. Blejer, Mario I. & Eden, Benjamin, 1979. "A note on the specification of the fisher equation under inflation uncertainty," Economics Letters, Elsevier, vol. 3(3), pages 249-255.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Christopher J. Neely & David E. Rapach, 2008. "Real interest rate persistence: evidence and implications," Review, Federal Reserve Bank of St. Louis, vol. 90(Nov), pages 609-642.
    2. Anari, Ali & Kolari, James, 2019. "The Fisher puzzle, real rate anomaly, and Wicksell effect," Journal of Empirical Finance, Elsevier, vol. 52(C), pages 128-148.
    3. Basse, Tobias & Wegener, Christoph, 2022. "Inflation expectations: Australian consumer survey data versus the bond market," Journal of Economic Behavior & Organization, Elsevier, vol. 203(C), pages 416-430.
    4. Somayeh Madadpour & Mohsen Asgari, 2019. "The puzzling relationship between stocks return and inflation: a review article," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 66(2), pages 115-145, June.
    5. Anari, Ali & Kolari, James, 2016. "Dynamics of interest and inflation rates," Journal of Empirical Finance, Elsevier, vol. 39(PA), pages 129-144.
    6. Peter Kehinde, Mogaji, 2010. "Fisher Effect and the Relationship between Nominal Interest Rates and Inflation: The Case of Nigeria," MPRA Paper 98760, University Library of Munich, Germany.
    7. S, Surayya, 2018. "Alternative Specifications of Fisher Hypothesis: An Empirical Investigation," MPRA Paper 90320, University Library of Munich, Germany.
    8. Guglielmo Maria Caporale & Luis Gil-Alaña, 2019. "Testing the Fisher hypothesis in the G-7 countries using I(d) techniques," International Economics, CEPII research center, issue 159, pages 140-150.
    9. İsmet Göçer & Serdar Ongan, 2020. "Asymmetric Impacts of Inflation on the US Bond Rates and FED’s Pre-Emptive Policy," Econometric Research in Finance, SGH Warsaw School of Economics, Collegium of Economic Analysis, vol. 5(2), pages 143-157, December.
    10. Jens Weidmann, 1997. "New Hope for the Fisher Effect? A Re-Examination Using Threshold Cointegration," Macroeconomics 9705005, University Library of Munich, Germany.
    11. Radó, Márk, 2003. "Infláció, tőkeköltség és a magyar tulajdonosok versenyhátránya [Inflation, capital costs and the competitive disadvantage of Hungarian owners]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(11), pages 964-987.
    12. Booth, G. Geoffrey & Ciner, Cetin, 2001. "The relationship between nominal interest rates and inflation: international evidence," Journal of Multinational Financial Management, Elsevier, vol. 11(3), pages 269-280, July.
    13. Rapach, David E. & Weber, Christian E., 2004. "Are real interest rates really nonstationary? New evidence from tests with good size and power," Journal of Macroeconomics, Elsevier, vol. 26(3), pages 409-430, September.
    14. Chang, Tsangyao & Ranjbar, Omid & Tang, D.P., 2013. "Revisiting the mean reversion of inflation rates for 22 OECD countries," Economic Modelling, Elsevier, vol. 30(C), pages 245-252.
    15. Uddin, Gazi Salah & Alam, Md. Mahmudul & Alam, Kazi Ashraful, 2019. "An Empirical Evidence of Fisher Effect in Bangladesh: A Time-Series Approach," SocArXiv udpwj, Center for Open Science.
    16. Andrew Phiri, 2023. "Fisher’s hypothesis in time–frequency space: a premier using South Africa as a case study," Quality & Quantity: International Journal of Methodology, Springer, vol. 57(5), pages 4255-4284, October.
    17. Arnold, Stephan & Auer, Benjamin R., 2015. "What do scientists know about inflation hedging?," The North American Journal of Economics and Finance, Elsevier, vol. 34(C), pages 187-214.
    18. Luis A. Gil-Alana & Andrea Mervar & James E. Payne, 2017. "The stationarity of inflation in Croatia: anti-inflation stabilization program and the change in persistence," Economic Change and Restructuring, Springer, vol. 50(1), pages 45-58, February.
    19. Noor Ghazali & Shamshubariah Ramlee, 2003. "A long memory test of the long-run Fisher effect in the G7 countries," Applied Financial Economics, Taylor & Francis Journals, vol. 13(10), pages 763-769.
    20. Ekaterini Panopoulou, 2005. "A Resolution of the Fisher Effect Puzzle: A Comparison of Estimators," Money Macro and Finance (MMF) Research Group Conference 2005 18, Money Macro and Finance Research Group.

    More about this item

    Keywords

    Fisher equation; Fisher hypothesis; Fisher effect; money illusion; nominal interest rate; purchasing power of money; value of money.;
    All these keywords.

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • B00 - Schools of Economic Thought and Methodology - - General - - - History of Economic Thought, Methodology, and Heterodox Approaches
    • B31 - Schools of Economic Thought and Methodology - - History of Economic Thought: Individuals - - - Individuals

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ngi:dpaper:07-05. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/gripsjp.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.