KEYNES and THE KEYNESIANS ON THE FISHER EFFECT
| Published date | 01 November 1994 |
| Author | Allin Cottrell |
| DOI | http://doi.org/10.1111/j.1467-9485.1994.tb01136.x |
| Date | 01 November 1994 |
Scottish
Journal
of
Polirinrl
Economy,
Vol.
41.
No.
4.
November
1994
@
Scottish Economic Society
1994.
Published by Blackwell Publishers.
108
Cowley Road, Oxford
OX4
IJF.
UK
and
238
Main Strm. Cambridge.
MA
02142,
USA
KEYNES AND THE KEYNESIANS ON THE
FISHER EFFECT
Allin Cottrell*
I INTRODUCTION
The object of this paper is to see what can be learnt about (a) the Fisher effect
and (b) Keynesian and post Keynesian monetary theory, by examining the ana-
lyses of the former offered by proponents of the latter.
I
begin with a brief
exposition of Irving Fisher’s own views
on
the Fisher effect.
I
then move to
Keynes’s critique in
The General Theory,
the discussion of which motivates a
further and somewhat deeper examination of Fisher’s views. The analysis that
follows leads into the accounts of the matter to be found
in
the later Keynesian
(and post Keynesian) literature. There is more than one useful survey of the
literature on the Fisher effect out there already,
’
but
I
think this exercise may
be worthwhile for the following reasons. First, it seems to me that Keynes’s dis-
cussion of Fisher is both obscure and grossly unfair to Fisher, yet all the same
the arguments of
The General Theory
do provide the basis for
a
more adequate
critique, and I’m not aware of an account which successfully untangles these
points. Second, while Mundell
(1963)
and Sargent
(1972)
each offer interesting
extensions of Keynes’s argument, neither of these authors explicitly identifies
the conditions that are necessary (or sufficient)
to
overthrow Fisher’s theor-
etical conclusion (and neither,
I
believe, do previous surveys of the debate).
Third, the existing surveys are becoming somewhat dated, and do not discuss
the relatively recent post Keynesian contributions that
I
examine in Section
V
below.
11
FISHER
ON
THE
FISHER
EFFECT:
TAKE
ONE
Fisher’s original argument is well known: absent ‘money illusion’ both the
supply and the demand for loanable funds should be functions of the
ex ante
real rate of interest (nominal interest rate minus expected inflation), rather than
simply the nominal rate. Thus the equilibrium value
of
the
ex ante
real rate
should be basically invariant with respect to changes in
expected
inflation. If,
in addition, people have a reasonable degree of foresight regarding inflation,
then the
expost
real rate of interest also ought to be basically invariant with
respect to
actual
inflation, inflation ‘surprises’ apart. Or in other words, the
nominal rate of interest should move in response to changes in anticipated
’For
instance LeRoy
(1973),
Humphrey
(1983),
Wood and Wood
(1985,
chapter
18).
*
Department
of
Economics, Wake Forest University,
NC
416
KEYNES AND THE KEYNESIANS ON THE FISHER EFFECT
417
inflation/deflation in such
a
manner as to preserve the underlying real equi-
librium in the market for loanable funds. This argument is set out at length in
Fisher
(1896),
and again, with little alteration, in Fisher
(1930).
Fisher was not content, however, just to make his theoretical point: in both
of these texts we find very extensive statistical investigations. And as
is
well
known, while Fisher found some degree
of
qualitative support for his position
(i.e., nominal interest rates tended
on
average to be
somewhat
higher in times
of
rapid inflation), he also found that the adjustment
of
the nominal rate fell
far short
of
his theoretical expectation. The real-world Fisher effect seemed to
be both partial and subject to very long lags.
The only explanation
of
this that Fisher was able to offer involved either
‘money illusion’ proper (i.e., failure
to
take into account expected movements
in the price level) or long lags in the formation
of
(adaptive) expectations
of
inflation. Carmichael and Stebbing
(1983)
quite reasonably talk
of
a ‘Fisher
paradox’: Fisher was the author
of
what many economists have regarded as
a
compelling theoretical argument, but at the same time the bearer
of
the bad
news that the economy (apparently) just doesn’t work like that. Subsequent
investigations
of
the matter have typically taken the form of either (a) the
provision
of a
theoretical rationale
for
a
partial (and/or lagged) Fisher effect,
which does
not
depend on money illusion or long lags in the formation
of
expectations,
or
(b) the rejection
of
the basic logic of the Fisher effect. As we
shall see, within the field
of
Keynesian monetary theory-broadly con-
strued-both sorts
of
response are evident. We begin with Keynes’s own views
on Fisher.
111
KEYNES
ON
FISHER
First
of
all, it is worth noting the context
of
Keynes’s discussion of the Fisher
effect in
The General Theory:
it occupies two pages of chapter
11
(Keynes,
1936,
pp.
142-3)’
where the general theme
is
‘The Marginal Efficiency of
Capital’. More specifically, the context is Keynes’s idea that the MEC ‘depends
on the
prospective
yield of capital, and not merely on its current yield’ (p.
141).
It should also be noted that this section
precedes
the chapters dealing
specifically with the rate
of
interest (chapters
13-15,
and
17),
a
point which
may be
of
some significance, as we shall see below. (For Keynes, of course, the
MEC and the rate
of
interest are quite distinct, although they are equal in
equilibrium: investment is pushed to the point on the MEC schedule at which
the specific value
of
the MEC equals the rate
of
interest.)
At any rate, here is Keynes’s argument. The marginal efficiency of capital
represents the expected profitability of investment in money terms.
If
investors
come to expect a general rise in prices, therefore, this will raise the MEC sched-
ule: if both money costs and revenues are expected to expand in
a
common pro-
portion, the gap between the two will also be expected to expand. As Keynes
puts it, ‘This is the factor through which the expectation
of
changes in the value
of money influences the volume
of
current output. The expectation
of
a
fall
in
the value of money stimulates investment, and hence employment generally,
0
Scottish Economic Society
1994
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