VoxEU Column Macroeconomic policy


There is a lot in a name. This column looks at the ideas that are wrongly attributed to Irving Fisher and David Ricardo. Incorrect attribution can be more dangerous than it seems, and the prestigious names of Ricardo and Fisher have been used to justify inattentive fiscal and monetary policies. Fisher, for instance, understood that under certain circumstances, including perfect foresight, real interest rates might be immune to changes in inflation, at least over the long haul. But he rejected the premises needed to erect such a theory.

In economics, as in other disciplines, it is common practice to name models, theorems, and empirical results after their originators. In macroeconomics, we have the Phillips curve, an empirical relationship between inflation and unemployment first documented for the UK by A W Phillips, an engineer from New Zealand. And we have Okun’s law, an empirical relationship between unemployment and the gap between actual and potential output first laid out for the US by Arthur M. Okun at Yale. Moreover, we have the Solow model that bears the name of Nobel laureate Robert M Solow at MIT, who presented his seminal growth model in 1956. The list also includes the Heckscher-Ohlin and Stolper-Samuelson theorems in trade theory, the Baumol-Tobin and Modigliani-Miller theorems in monetary theory, the Mundell-Fleming model in international finance, and even the relatively recent Taylor and Giudotti-Greenspan rules of monetary policy.

The pattern is pretty clear – you make a discovery (or perhaps you just make a point!) and it may become irretrievably associated with your name.

Or it may not.

Or something completely different can happen. Just ask David Ricardo and Irving Fisher.

Ricardian equivalence: When you cross it

Innocent readers may be excused for thinking that David Ricardo (1772-1823) originated the idea that it makes no difference whether government expenditures are financed by taxation or by borrowing, on the grounds that taxpayers anticipate the increased future tax burden that arises from increased borrowing today, making them indifferent between the two. This simple idea requires you to think that ordinary taxpayers reduce their consumption today to prepare for a heavier tax burden decades from now. If true, this proposition greatly reduces the efficacy of fiscal policy.

The attribution of this proposition to Ricardo is unfair to him because, even if he exposited the logic behind it, he found the proposition unconvincing. In the words of Ricardo (1817): “… it must not be inferred that I consider the system of borrowing as the best calculated to defray the extraordinary expenses of the State. It is a system which tends to make us less thrifty – to blind us to our real situation”. Like modern behavioural economists, Ricardo understood that in their daily lives most people abide by the old saying, "worry about that bridge when you cross it".

Here is how three modern macroeconomics textbooks handle Ricardo:

  • N Gregory Mankiw (2013) writes: “Hence, financing the government by debt is equivalent to financing it by taxes. This view is called Ricardian equivalence after the famous nineteenth-century economist David Ricardo because he first noticed the theoretical argument”.
  • Olivier Blanchard (2006) writes: “One extreme view is that once the government budget constraint is taken into account, neither deficits nor debt have an effect on economic activity. This argument is known as the Ricardian equivalence proposition. David Ricardo, a nineteenth-century English economist, was the first to articulate its logic. His argument was further developed and given prominence in the 1970s by Robert Barro, then at Chicago, now at Harvard University. For this reason, the argument is also known as the Ricardo-Barro proposition”.
  • J Bradford DeLong and Martha L Olney (2006) get it right: “this alternative view of the long-run (and also the short-run) effects of debt and deficits is called ‘Ricardian equivalence’, after David Ricardo, who does not seem to have held the view; it should be called ‘Barrovian equivalence’, after its most effective and powerful advocate, Harvard macroeconomist Robert Barro” (see Barro 1974).

The Fisher effect: When contracts are made in unstable money

Many writers continue to attribute to Irving Fisher the idea that real interest rates are insensitive to changes in inflation and to suggest that Fisher regarded such insensitivity as somehow natural. For example, Okun (1981) states: “As Fisher saw it, an extra 1 percentage point of expected inflation raises the nominal expected rate of return on real capital assets by 1 percentage point and induces a parallel increase of 1 percentage point in bond and bill yields to keep expected returns in balance”. Further, using quarterly US data for 1954-1969, Feldstein and Eckstein (1970, 366) write: “the data thus confirm the two basic Fisherian hypotheses: (1) in the long run, the real rate of interest is (approximately) unaffected by the rate of inflation, but (2) in the short run, the real rate of interest falls as the rate of inflation increases”. If true, this proposition reduces the effectiveness of both monetary and fiscal policy by making real interest rates and hence also investment, saving, and other macroeconomic aggregates immune to changes in inflation via real interest, at least in the short run.

Here is how the three textbooks cited above handle Fisher.

  • Mankiw (2013) writes: “The one-for-one relation between the inflation rate and the nominal interest rate is called the Fisher effect… In data from the late nineteenth and early twentieth centuries, high nominal interest rates did not accompany high inflation. The apparent absence of any Fisher effect during this time puzzled Irving Fisher. He suggested that inflation ‘caught merchants napping’”.
  • Blanchard (2006) writes: “The result that, in the medium run, the nominal interest rate increases one for one with inflation is known as the Fisher effect, or the Fisher hypothesis, after Irving Fisher, an economist at Yale University, who first stated it and its logic at the beginning of the twentieth century”.
  • DeLong and Olney (2006) write: “Thus when the expected inflation rate rises, we would expect in the long run to see the nominal interest rate rise with it, point-for-point. This theoretical prediction – and rough empirical regularity – is called the Fisher effect”.

The Fisher effect, if described as an empirical relationship, is a misnomer because Fisher’s (1930) own data on interest rates and inflation covering New York, London (see Figure 1), Paris, Berlin, Calcutta, and Tokyo from 1825 to 1927 suggest that nominal interest rates do not come close to mirroring the movements in inflation, as Mankiw (2013) points out, even in the long run. As shown by Gylfason (2016), all of Fisher’s data show interest rates to evolve less rapidly than inflation and to change less than inflation. The assumption of a common dynamic structure in Fisher’s six cities suggests inflation cycles of about six years, cycles that do not show up in the interest rate series. The failure of nominal interest rates to imitate the inflation cycles underlines the lack of sensitivity of nominal interest rates to inflation. The Fisher effect, defined as a point-for-point effect of inflation on nominal interest rates, is a misnomer as an empirical result and must rather be understood as a theoretical possibility that is not supported by Fisher´s data.

Figure 1. Irving Fisher’s data: Nominal interest rates and inflation, London, 1825-1927

In Fisher’s time, as Figure 1 shows, while inflation did not hesitate to move into negative territory, nominal interest rates did not follow. In London, wholesale prices rose merely by 9% from 1820 to 1927, while in New York they remained unchanged from 1867 to 1926, as they did in Berlin from 1866 to 1911; in Paris, wholesale prices fell by 18% from 1872 to 1914 (Fisher 1930). In Fisher’s data, deflation was nearly as common as inflation, reaffirming his inference that deflation makes both real interest rates and debt burdens rise, leading to distrust, distress selling, bankruptcies, bank runs, reduced output and trade, and unemployment (Fisher 1896, 1933). There can be no controversy about deflation making real interest rates rise when nominal interest rates refuse to go below zero, as was the case in Fisher’s data. It may have been natural in those days to expect nominal interest not to follow inflation because bouts of inflation were often followed by deflation, since inflation expectations were well anchored by the gold standard.

These results are consistent with those of Fisher himself. As Tobin (1987) and Dimand (1999), among others, point out, both Fisher’s theory of interest and his reading of the historical record suggested to him that real interest rates varied inversely with inflation, and that the adjustment of nominal interest rates to changes in inflation took a very long time (Fisher 1896). In Fisher’s (1930) words: “… when prices are rising, the rate of interest tends to be high but not so high as it should be to compensate for the rise; and when prices are falling, the rate of interest tends to be low, but not so low as it should be to compensate for the fall”. Fisher (1930) describes the relationship between interest rates and inflation also thus: “When the price level falls, the rate of interest nominally falls slightly, but really rises greatly and when the price level rises, the rate of interest nominally rises slightly, but really falls greatly”. Here Fisher means the rate of change of the price level even if he says only “price level”. Fisher (1907) made a clear distinction between the two: “Falling prices are as different from low prices as a waterfall is from sea level.”


There is a lot in a name. Irving Fisher has suffered similar treatment as David Ricardo when different authors have attached his name to an empirical relationship that he rejected. The prestigious names of Ricardo and Fisher have been used to justify inattentive fiscal and monetary policies. Fisher’s (1930) view was that “… men are unable or unwilling to adjust at all accurately or promptly the money interest rates to changed price levels. Negative real interest rates could scarcely occur if contracts were made in a composite commodity standard. The erratic behaviour of real interest is evidently a trick played on the money market by the ‘money illusion’ when contracts are made in unstable money”. A few pages earlier, Fisher (1930) had written:  “Most people are subject to what may be called “the money illusion,” and think instinctively of money as constant and incapable of appreciation or depreciation”. Fisher understood that under certain circumstances, including perfect foresight, real interest rates might be immune to changes in inflation, at least over the long haul, but he rejected the premises needed to erect such a theory.


Barro, R J (1974), "Are Government Bonds Net Wealth?" Journal of Political Economy 82(6): 1095–1117.

Blanchard, O (2006), Macroeconomics, 4th ed. Pearson Prentice-Hall.

DeLong, B J, and M L Olney (2006), Macroeconomics, 2nd ed. McGraw-Hill Irwin.

Dimand, R W (1999), “Irving Fisher and the Fisher Relation: Setting the Record Straight”, Canadian Journal of Economics 32(3), May: 744-750.

Feldstein, M, and O Eckstein (1970), “The Fundamental Determinants of the Interest Rate”, Review of Economics and Statistics 52(4), November: 363-375.

Fisher, I (1896), Appreciation and Interest, AEA Publications 3(11), August: 331-442.

Fisher, I (1907), The Rate of Interest, MacMillan.

Fisher, I (1930), The Theory of Interest, MacMillan.

Fisher, I (1933), “The Debt-Deflation Theory of Great Depressions”, Econometrica 1(4): 337-357.

Gylfason, T, H Tómasson, and G Zoega (2016), “Around the World with Irving Fisher”, North American Journal of Economics and Finance 36 April: 232–243.

Mankiw, N Gregory (2013), Macroeconomics, 8th ed. Worth Publishers, Palgrave MacMillan.

Okun, A M (1981), Prices and Quantities: A Macroeconomic Analysis, Basil Blackwell.

Ricardo, D (1971), Principles of Political Economy and Taxation 1817, Penguin Books.

Tobin, J (1987), “Fisher, Irving”, in J Eatwell, M Millgate, and P Newman (eds.), The New Palgrave Dictionary of Economics 2: 369-376.

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