Irving Fisher Has Come Back Into Fashion

It is extraordinary how the great American Economist, Irving Fisher, has come back into fashion. In the last week I have seen substantial references to him in The Times of London, the Wall Street Journal, and the Sunday Independent, also a London paper. Only one of these articles did I write myself. This follows the flurry of interest in the ideas of Maynard Keynes, who died in 1946.

Irving Fisher, who died in 1947, had the advantage over Keynes of living in the United States during the crucial period of the Great Depression, from 1929 to 1935. He had already established his reputation as an economist in the early years of the twentieth century, primarily by his work on the changing levels of prices. He did not actually invent, but he developed the equation of exchange. As he later became convinced that the business cycle was caused by the movement of prices, one can regard the equation of exchange as essential to his understanding of the causes of the Great Depression.

I find that a surprising number of people can remember the equation of exchange, which they have learned at some stage of their student careers. Fifty years later, they will say “isn’t that the equation which says MV = PT?” Sometimes they can remember what the letters actually stand for. M is the quantity of money, V is the velocity at which it circulates, P is the general price level, and T represents the number of economic transactions in a given period.

In the Great Depression, we know what happened to the four variables. The quantity of money fell, at least in New York between 1929 and 1933; the velocity of circulation declined, prices fell and the number of transactions fell. Irving Fisher advocated the increase in the quantity of money, and persuaded Franklin Roosevelt that reflation should be part of the New Deal. Roosevelt was a tricky President to advise. He agreed with everyone when he was in the room with them. “That’s grand, just grand,” he would say, but he would often fail to adopt the policy. However, he did reflate by raising the dollar price of gold.

The difficulty was that the velocity of circulation could not be controlled in the same way. In New York the velocity of circulation fell by more than 70 per cent between October 1929 and March 1932.

We know that the velocity of circulation has fallen in our own 2008 crisis. Banks have lost trust in each other and have been reluctant to lend, either to their clients or to other banks. As a result money circulates slowly.

Governments can remedy an actual shortage of funds; if the worst comes to the worst they can create fiat money – they can simply print the stuff. Of course, that has an inflationary risk, but the risk of inflation can be offset against the depression itself – which has a powerful deflationary force.

However, Governments cannot print an acceleration of velocity. That is essential to recovery, and indeed it is an essential part of the reflation which almost everyone now recommends. Yet an addition to the money supply in quantitative terms does not automatically result in an acceleration of its velocity.

This was argued about in the 1930s. More conservative economists believed that the conditions of confidence which were required to raise the velocity of circulation could only be obtained by a restoration of the gold standard. I think it possible that banks would have wanted to hoard gold if the gold standard had remained intact. Britain, however, had left the gold standard in 1931.

Yet prudence is still important. A mad rush to print money would not reflect confidence. We need a recovery in the velocity of circulation. We shall only achieve it when bankers trust each other – and indeed when they trust their clients.

William Rees-Mogg
Markets and Money

William Rees-Mogg
Leading political editor William Rees-Mogg is former editor-in-chief for The Times and a member of the House of Lords. He has been credited with accurately forecasting glasnost and the fall of the Berlin Wall – as well as the 1987 crash. His political commentary appears in The Times every Monday. His financial insights can only be found in the Fleet Street Letter, the UK's longest-running investment newsletter.

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5 Comments on "Irving Fisher Has Come Back Into Fashion"

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Matt M

Problem with reduced velocity of money is not a lack of confidence per se, but governments pushing prevailing interest rates (temporarily) below equilibrium. This has the effect of risk of loans (risk of default) being greater than reward (interest earned). Banks/financiers are simply making a rational decision and refusing to lend at present artificially low interest rates. If interest rates were allowed to rise to equilibrium lending would recommence. Unfortunately western Govts cannot allow this as would cause implosion of overly leveraged consumer.

Jon Bain

Fascinating article. What causes the lack of confidence? In my view, its lack of trust in the legal framework. Any economic system, whatever it may be, needs to be underpinned by an honest and fair legal system. Young people (especially young men) do not trust the legal system, because it is completely corrupted. Have you ever heard anyone say anything nice about a lawyer?


And the velocity threat is why they will eventually either monetise their way to disaster or bring in death duty as the source of funds to bail out the consumer and banks ie: to refloat both demand and supply respectively.

Greg Atkinson
I love it when economists try to be real scientists and start putting together equations :) (as basic as they are) If an equation or theory works for a while everyone is happy, if it stops working it is buried, but years later if it looks like it might be applicable again it is dusted off and given a another run. I think we can forget all the economic mumbo jumbo because we know until the consumer starts spending again things are unlikely to improve. (and you can probably come up with a few dozen equations to reflect that truism)… Read more »
Charles  Norville
There are better formulas that consider sustainability. The only real formula for capitalism is Monopoly = Greed, where the bi product is the underclass of people. Yet the US hold Keynes up as a God. My thoughts on the process go to natural order of things – the energy & materials per capita ratio. Which means that to have an affluent world you are going to have the average such ratio that gives also sustainability. Look at China’s ratio despite its output it is clearly unsustainable because of the size of their population and pollution of its land affecting the… Read more »
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