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DEVOLUTION OF THE FISHER EQUATION: Rational Appreciation to Money Illusion

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  • 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) was expressed in terms of the expected appreciation of money [percent change in E(1/P)] whereas the ubiquitous conventional Fisher equation (CFE) uses expected goods inflation [percent change in E(P)]. Since Jensen?s inequality implies the non-equivalence of the two equations, the OFE is not subject to standard criticisms of non-rationality leveled against the CFE. The puzzling substitution of inflation for expected money appreciation in Fisher (1930) is resolved by taking into account Fisher's theory of “money illusion.”

Suggested Citation

  • James R. Rhodes, 2006. "DEVOLUTION OF THE FISHER EQUATION: Rational Appreciation to Money Illusion," GRIPS Discussion Papers 08-04, National Graduate Institute for Policy Studies, revised Jun 2008.
    • Handle: RePEc:ngi:dpaper:08-04
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    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

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