THE GREAT DEPRESSION IN IRVING FISHERS THOUGHT Giovanni Pavanelli Dipartimento di Scienze Economiche e Finanziarie G.

Prato Universit di Torino (e-mail: giovanni.pavanelli@unito.it) December 2001 Abstract This paper offers a critical re-examination of Fishers views on the origin of the Great Depression, his debt-deflation theory and the policy measures he advocated. On the eve of the stock market crash in October 1929 Fisher predicted that the share prices were not overvalued and that their increase was due to new profit opportunities created by technological innovation and sharp rises in productivity. As the depression worsened, however, he became convinced that new theoretical explanations were needed and presented a new model (debt-deflation theory) based on the interaction of real and monetary aspects. In 1932 he also became an active supporter of a stamped money plan aimed at counteracting widespread hoarding. During the New Deal he supported expansionary monetary measures and promoted a revision of the banking system aimed at abolishing fractional reserves (100% money). In the meantime he opposed Roosevelts labour and industrial policies and, more generally, any intervention by the government on economic activity with the exception of the control on money supply. JEL Classification: B2, B3, E5 Key words: Great depression, debt-deflation, Irving Fisher, stabilization policies

An earlier version of this paper was presented at the Fifth Annual Conference of the European Society for the History of Economic Thought, Darmstadt, February 2001. I am

grateful to the seminar participants and to an anonymous referee for helpful comments. The usual disclaimer applies.4 1. Introduction The Great Depression was, without doubt, a watershed in contemporary economic thought: Keynes General Theory can be read in large part as a sophisticated intellectual effort to explain and counteract this unprecedented downturn in economic activity. Nevertheless, major debates and controversies notwithstanding, we are still far from having a complete explanation of this event. The stock market crash of October 1929 and its connection with the subsequent severe contraction of real output have also been the object of conflicting interpretations. During the past decade, however, considerable progress has been made. Research, which was traditionally centred on the events internal to the United States, has now broadened in scope and stresses such factors in the spread and worsening of the depression as the gold standard and the related rules of the game on the one hand and the First World War's legacy of overall indebtedness and reciprocal mistrust and rivalry on the other (Eichengreen, 1992; Temin, 1993). Some recent studies have focused on the effects of the fall in prices on the financial stability of households and firms (debtdeflation effects: cf. Bernanke-Gertler, 1990; King, 1994; Wolfson, 1996). In this framework, a growing number of studies have taken up the theoretical contribution and policy proposals of Irving Fisher (cf. Barber, 1996, 1999; Dimand, 1994, 1995; Steindl, 1995, 1999). Fisher, who is considered the leading American economist of the twentieth century, was also one of the most acute observers of the complex and dramatic macroeconomic events of his day and one of the most active in seeking a solution to the problems they posed for the scientific community. For Fisher as for other economic scholars, the Depression was an unexpected event that demanded new answers. As the crisis was gathering, he had voiced a series of optimistic assessments of the fundamental soudness of the American economy and had ruled out any possibility that the stock market would collapse. The crash of 29 and the vicious circle of falling prices and the aggravation of real private sector debt led him make substantial modifications of his theory of economic fluctuations and to elaborate a new theory of great depressions (debt-deflation theory) which, as noted, has gained renewed prominence of late. 5 This paper offers a critical re-examination of Fishers view of the origins of the Great Depression, his debt deflationary theory and the policy measures he advocated.

2. Interpreting the stock market crash and the Great Depression On the eve and on the morrow of the stock market crash of 29 Fisher who, by the way, had put most of his own wealth in shares issued a series of reassuring statements on the stock market trend and, more generally, on the state of the American economy. In February 1929, in the face of signs of a reversal of the upward trend in stock prices, he wrote: The refluent wave of trading has left prices of securities, and especially of common stocks, on a shelf where they will remain permanently higher than in past years (Fisher, 1929a). And again, and even more explicitly, in September: Stock prices are not too high and Wall Street will not experience anything in the nature of a crash (Fisher, 1929b). These pronouncements, which were almost immediately shown to be completely wrong, certainly undermined the Yale economists academic credibility as well as public trust in his analyses 1 . Yet Fishers forecasts were neither naive nor totally unfounded. In brief, he held that share prices incorporated the present value of expected dividends; more generally, the stock market reflected expectations on companies future performance and that of the economy as a whole. In Fishers view, immediately after the First World War the industrialised countries, and the United States in particular, had experienced a great expansion in scientific and technological research and its systematic application to manufacturing. American industry had thus greatly increased its productivity and was able to develop and market new consumer goods (the automobile, the radio, the telephone). Furthermore, efficiency gains had been obtained thanks to better use of productive factors and the improved living conditions of the working class. There were, 1 In the thirties, Fisher was relatively isolated in the scientific community, and his policy proposals, which, seen with hindsight, went in the right direction, were received poorly and in some cases with hostility. 6 therefore, expectations of considerable increases in production and profits 2 These . elements, according to Fisher, explained between two-thirds and three-fourths of the

rise in the stock market between 1926 and September 1929 (Fisher, 1930) 3 ; this apparently healthy trend, however, had been altered by risky speculative manoeuvres, facilitated by an excessively permissive credit policy. The stock market had therefore become increasingly precarious and vulnerable to bearish speculation, until the crash of October-December, which ended up bringing down even first-rate securities. In 1930 and 1931 Fisher remained basically optimistic about the prospects of the American economy and continued to predict the imminent recovery of stock prices. In any case, he affirmed repeatedly, it was not at all inevitable that the crisis in the financial markets would spread to the real economy. The depression, in other words, could be avoided as long as businessmen did not let themselves be dominated by pessimism and did not cut back their production plans. It is also significant, in the light of the recent rediscovery of the international dimensions of the Depression, that Fisher did not limit his considerations to the American situation. If a rapid recovery of the economy was desired, he wrote, it was necessary to get free of the heavy legacy of the World War, such as the inter-allied debts 4 , and to radically review American customs policy, abolishing the 1930 SmootHawley tariff, which had reduced international trade and had worsened the current account deficits of the European countries, preventing them from paying their debts to America in the only way possible, namely by exporting their own products. As the depression worsened, Fisher became convinced that the crisis could not be simply interpreted as a downturn in the business cycle, however severe, and that it was something radically different that demanded a new theoretical explanation. Starting 2 In Fishers view, another crucial factor was the action of the investment trusts (mutual funds): Investment trusts have removed much of the risk inherent in common stocks by spreading the risks over a large number of stocks [] The elimination of risks has greatly stimulated the demand for the formerly despised common stocks and sent their values up all

along the line (Fisher, 1929a, p. 64). 3 This stimulating even if controversial thesis has been rediscovered by recent literature (cf., among others, Sirkin, 1975; De Long-Schleifer, 1991). 4 One of the most threatening aspects of the present depression is the staggering burden of international debts left by the World War. These debts are a formidable obstacle to recovery not only because they operate, as all debts do, to intensify depressions, but also because they are so largely political in nature and incite to political unrest (Fisher, 1931). 7 in January 32, therefore, he began to devise a new theory of great depressions, based on the interaction of two factors: i) an initial situation of over-indebtedness; ii) a dynamic process of price reduction 5 The over-indebtedness could have had many . causes and did not necessarily imply the hypothesis of irrationality in the behaviour of economic agents: on the contrary, it could be explained as a rational response to the profit opportunities created by technological improvements and inventions. In any case, according to Fisher, a real shock would usually trigger short-term and not particularly serious adjustment processes. The explosive dynamic process typical of great depressions had its origins, rather, in the fact that the initial over-indebtedness was progressively aggravated by deflation. In brief, the model considered firstly a system burdened with debt, but otherwise in equilibrium, albeit an unstable one; in this situation, a minor shock (bad news or a fall in share prices) was enough to undermine the confidence of either debtors, creditors or both and to lead to a first wave of liquidation of debts. The rush to liquidate led to distress selling 6 and the consequent sharp fall in share prices and a contraction of bank deposits. This triggered deflation, which in turn increased the stock of debt in real terms. 7 In essence, the attempt by individuals and banks to reduce their debt touched off a perverse dynamic process that

worsened their situation in real terms, dragging them towards financial collapse. The immediate consequence was a wave of bankruptcies that drove prices still further down. The generalised reduction in prices also damaged the entrepreneurs who were not in debt: their sales prices fell faster than costs, squeezing profits. Now, in a capitalistic system, Fisher writes, it is the profit taker who usually makes the decision as to the rate at which his enterprise is to be run (1932a, p. 30). A fall in profits was thus bound to bring a general reduction in output and employment. Taken together, these factors 5 The debt-deflation theory was illustrated for the first time by Fisher in a paper presented at the annual meeting of the American Association for the Advancement of Science in New Orleans in January 1932. The theory was expounded most fully in a volume published that year (Booms and Depressions). The following year, an abridged but particularly clear version of the theory was published in Econometrica (cf. Fisher, 1933a; Dimand, 1994). 6 Distress selling means selling not because the price is high enough to suit you, which is the normal characteristic of selling, but because the price is so low it frightens you (Fisher, 1932b). 7 The very effort [...] to pay debt [...] resulted in increasing debts; and the more the American people tried to get out of debt, the more they really got in, when the debts are measured in real commodities (Fisher, 1934a, p. 128). 8 produced a lack of confidence and pessimism that translated into a general rush towards money: phenomena of hoarding thus multiplied, further reducing the velocity of circulation of money and lowering price levels; consumption contracted even further. 8 Again in this case, therefore, the effort by each agent to improve his own position led to a worsening of the overall situation: Every man who hoards does it for his own protection; yet by hoarding he aggravates the very condition that started his fear (1932a, p. 36)

9 . In essence, if not adequately countered by the monetary authorities, the deflationary process will set in motion a perverse, self-fueling spiral bound to cause almost universal bankruptcy (Fisher, 1932a, 1933a). The debt-deflation theory, according to Fisher, explained what had happened in the United States and Europe between 1929 and 1932. Referring to the first factor, overindebtedness, Fisher had not the slightest doubt that on the eve of the stock market crash many firms and households were heavily indebted. One of the factors behind the enormous pyramid of debt that had been created was certainly the war: To support the most colossal of wars required prodigies of finance (1932a, p. 71). With reference to the United States, however, it was also necessary to consider other aspects. As noted, in the twenties the American economy was characterised by an investment boom, induced by the spread of technological innovations in manufacturing; this encouraged many firms to borrow heavily in expectations of higher profits. This process had also involved 8 In 9 The debt-deflation theory has been repeatedly criticised, in that in an economy characterised by inside debt (debt and credit are created within an economic system) a reduction in the price level should simply have redistributional effects between creditors and debtors without any consequence at the aggregate level. In an economy characterised by external debt, the reduction in prices should lead to an increase in demand through the Pigou effect. However, these results presume that agents are homogeneous, the exact opposite of Fishers assumption. If, instead, we assume perhaps more reasonably that debtors are characterised by a higher marginal tendency to consume than creditors, a reduction in prices translates into a reduction in demand; in most cases, as Tobin notes, this second effect tends to Booms and Depression Fisher clarified that in reality the relationships between these phenomena were more complex.

prevail over that of Pigou (Tobin, 1980). Moreover, in Fishers analysis the supply side plays an important role. According to Fisher, the debtors class coincided to a large degree with that of entrepreneurs; and, like Schumpeter, he believed that they played a crucial role in the economic system, thanks to their willingness to take risks and to seek out new opportunities for profit. When, as in the event of a protracted depression, a large number of entrepreneurs become 9 farming, stimulated by the sharply rising demand for food. Finally, the stock market boom had been accompanied and fueled by the growing indebtedness of financial operators. The Wall Street crash was the detonator, triggering the downward spiral predicted by debt deflation theory. It is in any case worth noting, in the light of todays debate, that Fisher also examined the international factors that had acted as accelerators of the deflationary spiral. Booms and Depression accurately reconstructed the dramatic events of 1931-32 that had thrown the world into depression: in particular, the link between bank failures in Austria and Germany, the ensuing crisis of sterling, motivated by the huge amount of short-term credit granted to these countries by the British monetary authorities, and the simultaneous speculative attack on American gold reserves. This in particular, wrote Fisher, demoralised the US banking community, spread hoarding and prompted bank runs: The bankers and their depositors began raiding each other in a cut-throat competition (1932a, p. 104). 3. The stamped money plan In any case coming to the policy proposal that Fisher drew from his debtdeflation theory at least in the United States the depression could have been avoided, or at any rate its consequences mitigated, by expansionary monetary policy. On this question, Fisher maintained that one of the causes of the collapse of the economy was the Federal Reserves abandonment of the stabilisation policy that had been pursued during the twenties by Benjamin Strong, the powerful governor of the New York Federal Reserve Bank, who died in 1928 (Fisher, 1934a 10 ; see also Steindl, 1995, pp. 103-4 and Cargill, 1992). Once the crisis had started, the right way to get out of it was,

in his view, reflation, in other words a monetary expansion to bring prices back up to insolvent, it can be difficult to replace them; and so one has severe reductions in employment and output. 10 I thoroughly believe that if [Strong] had lived and his policies had been continued, we might have had the stock market crash in a milder form, but after the crash there would not have been the great industrial depression. I believe some of the crash was inevitable because of over-indebtedness, but the depression was not inevitable (Fisher, 1934a, p. 151). 10 their pre-1929 level. Monetary policy, according to Fisher, was extremely effective, while fiscal policy could at best play an ancillary role. On this matter Fishers analysis contains some crucial elements that we must consider in some detail. A first point is the role that he ascribed to money in the economy. As is evident from his writings of the thirties, Fishers vision anticipates some aspects of the monetary circuit schemes recently taken up in the literature (cf. Graziani, 1988). Money, Fisher wrote, had to be considered as the fundamental distributive mechanism in the market economy; it was the bridge between the producer and the consumer (1932a, pp. 6-7). Money, he maintained in a text written in 1938, has become a prime necessity in our civilization. Without it goods cannot be sold, and will not be produced. There may be crying need for the necessities of life; there may be all the iron, steel, coal, lumber and other raw materials needed for manufacturing; there may be millions of able-bodied men anxious to work: Yet, if there is no money, there is no production; there is starvation and unemployment. 11 In advanced economies, of course, what mattered was not pocket-book money, or cash, but cheque-book money, or the bank deposits that constituted nine tenths of the total means of payment. The wave of bank failures of 1931-33 had thrown this mechanism into crisis, depriving the economy of the necessary liquidity. One of the crucial aspects of the depression, Fisher wrote, was the sudden destruction of more than a third of the circulating medium (8 billion dollars out of a total of 23), i.e. a notable part of the money necessary to transact our business 12 .

A second point is the transmission mechanism, which explains how an expansionary monetary policy can induce an increase in output and prices. Now, notwithstanding a few ambiguities, Fisher uses the term money to mean purchasing power in monetary terms: an increase in the means of payment available to agents, in 11 Irving Fisher Papers, Manuscript and Archives, Yale University Library, III, b. 25, f. 400, Democracy and Monetary Reform. Radio Address, August 1938. Goods, Fisher wrote in 1933, are not overproduced but deadlocked for want of a circulating transfer-belt called money (Fisher, 1933d, p. 3). 12 Irving Fisher Papers, Manuscript and Archives, Yale University Library, s. III, b. 25, f. 396, Ill., Feb. 28, 1936, p. 10. 11 other words, induces an increase in aggregate demand, which in turn pushes prices upwards 13 . Now, the first causal link in this schema (increase in demand followed by an increase in purchasing power), could certainly not be taken for granted. During a serious depression, agents tend to hoard their own liquid assets; a greater supply of liquidity, therefore, could have no real effect. This crucial point was underscored by Keynes. Money, he wrote in Chapter 17 of the General Theory, is distinguished from other forms of wealth by the fact that its elasticity of production and substitution were zero or at any rate very small, and that its carrying costs were negligible; it therefore tended to become a bottomless sink for purchasing power (Keynes, 1973, p. 231). Fisher, in a different theoretical framework, was aware of this point, as is shown by his handling of hoarding in 14 In the second half of 1932, the . bleakest period of the Depression, he became a supporter - as a first concrete measure aimed at counteracting the tendency to hoarding - of a plan for stamp scrip or stamped money. Booms and Depressions Is a Managed Currency Workable? An Address to the Commerce Club, Chicago,

The proposal of stamped money had first been made at the end of the nineteenth century by the social reformer Silvio Gesell, 15 but the plan was not applied with 13 It was reported in Chicago that when a big bank there, which had been closed, was finally opened and the depositors had suddenly more money to spend, the department stores were crowded with customers for several days. Such restoration of buying power is exactly what has long been needed to restore business, raise the shrunken price level [...] and so make possible payment of debts, business at a profit, and re-employment (Fisher, 1934b, p. 5). 14 Hoarding is a slowing of currency turnover of the extremest kind. [...] Housewives and their breadwinners then become distrustful of everything except money. Bills and coins are confided to stockings or mattresses, or are put underground, or (in a larger way) stored in safety deposit vaults. Credit deposits may be hoarded too. In such banks as are considered safe, large credit deposits will be kept, but kept idle (1932a, p. 35). The following passage is also revealing: To stop hoarding, to take the idle money out from under the mattress, to quicken the turnover of bank deposits are essential parts of the recovery program. We want to re-employ idle money; it will help toward re-employing idle men and idle machines; it will help reflate the price level... (1933b, p. 5). 15 Silvio Gesell (1862-1930) was a German-born businessman. From 1886 to 1900 he lived in Argentina, where he managed a commercial firm. His interest in economic and social reform started in the 1880s, after he witnessed a severe deflation which nearly brought

the economy of the country to collapse. At the beginning of the century he wrote his main contribution, 1929). Gesell considered his stamped money plan as a part of a radical reform of the economic system aimed at abolishing the privileges of landowners and financial institutions and at enhancing free competition. 12 significant results until decades later. The first experiments were conducted in two small towns in Germany and Austria in 1931-32 (Blanc, 1998). In brief, stamped money was a promise of payment issued by a public body or municipality, usually with the guarantee of a bank, which circulated as a banknote but that, within a given period of time, could be taken out of circulation and converted into legal tender. Its peculiarity was that it was subject to a periodic tax (for example two cents per dollar per week) in the form of a stamp that had to be affixed to the back of the note. This made the plan a self-liquidating operation at no cost to the finances of the authority that issued the notes. The city could thus promote public works, remunerating workers who would otherwise remain idle. 16 The notes were obviously characterised by an high velocity of circulation, as every agent had an evident interest in spending the scrip quickly so as to avoid the tax (cf. Fisher, 1933d). During 1932 and 1933 several rural communities in the United States tried to put limited amounts of stamp scrip into circulation in order to reduce unemployment and increase consumption. The first experiment took place in Howarden, Iowa, and the example was soon followed by other municipalities and merchant associations in Iowa, Illinois and Kansas. When Fisher learned of the plans in the first half of 1932, he endorsed them enthusiastically. The information was brought to him by Hans Cohrssen, a member of a Free Economy League founded by Gesell (cf. Cohrssen, 1991). In several syndicated columns written between July 1932 and January 1933, Fisher presented the stamped money plan as an effective way of stimulating consumption and putting idle men to work. He included it among other plans for reflation and stabilization in the British edition of Booms and Depressions. In 1933, with the The Natural Economic Order, translated into English in 1929 (Gesell,

assistance of Cohrssen and of his brother Herbert, he wrote a guidebook on the subject (cf. Fisher, 1933d) and spent a good deal of energy promoting the plan among private associations and communities. 17 16 Naturally, this presupposes that stamped money was accepted as money by all agents as a group. 17 With the help of Mr. H.R.L. Cohrssen I have recently answered four or five hundred enquiries about it. The letters came from literally every state in the Union and were written by persons, largely in official positions, who have a practical interest in introducing stamp scrip in their several towns, cities and states (Fisher, 1933d, p. 1). 13 The Gesell plan also received favourable comment from Keynes: The idea behind stamped money, he wrote in the General Theory, is sound (Keynes, 1973, p. 357). However, he saw a difficulty that made its large-scale application problematic. Money, wrote Keynes, was by no means the only form of wealth characterised by a liquidity premium; it was therefore likely that, once it was subjected to a tax, agents would try to replace it with other assets, such as gold or silver, bankers cheques or other means of payment. In March 1933, in any case, all forms of substitute money were declared illegal by the Rooosevelt Administration, and the experiments came to an abrupt end. As we have seen, an essential point in Fishers plan was that the increase in demand, while necessary, was inevitably only a first step. To get out of the depression, a substantial rise in prices was also necessary. This point was constantly emphasized by Fisher in his writings from these years: The government should have borrowed and spent, thus contributing to reflation and to a higher price level. And every climb in the price level would have lowered the real debts, public and private [...] This would have stimulated business (1932a, p. 105) or again: An increase of prices means, for the producer, an increase of profits or a wiping out of losses. That in turn means an increase of business activity and a decrease in unemployment. This rise of prices tends to save us from the

two great evils of Depression -- bankruptcies and unemployment (1932, p. 10) 4. Fishers proposals during the New Deal Fisher did not tackle the problem of stabilisation only from a theoretical standpoint. Rather, he made great efforts to persuade policymakers and testified at the main Congressional hearings. In 1932, in particular, he strongly supported the Goldsborough Bill, which called on the Federal Reserve to take all available steps to raise the price level to its pre-1929 level and then to stabilise it. In addition, he corresponded regularly with President Roosevelt and the leading members of his Administration (cf. Allen, 1977; Barber, 1996). Although it is not easy 14 to determine the exact extent to which Fisher influenced the policies adopted in these years, it can be hardly denied that at least in the the first phase of the New Deal in 193334 the monetary measures of the government went in the direction he suggested. 18 In this sense, the ideas expressed by Roosevelt in his well-known July 1933 radio address during the London Conference are revealing: The United States, Roosevelt asserted, seeks the kind of dollar which a generation hence will have the same purchasing and debt paying power as the dollar value we hope to attain in the near future 19 For his . part, Fisher commented more and more positively on Roosevelts monetary policy measures, in the first place on his decision to suspend the gold standard. Fishers contribution in this area appears even more important if one considers that many of the most authoritative economists of the day and the most representative bankers tenaciously opposed these measures as dangerous and subversive, advocating the retention of the gold standard at all costs. 20 Fisher also openly praised the policy of raising the dollar price of gold, championed by George Warren and Frank Pearson of Cornell University and implemented by the Treasury during the course of the two years 1933-34 with massive purchases of gold (in other words, devaluing the dollar vis--vis the currencies that used the gold standard) with the aim of raising the prices of goods (cf. Warren-Pearson, 1933).

18 Interestingly, Roosevelts two most influential monetary experts, the economists James Harvey Rogers and George Warren, were both linked to some degree to Fisher. Harvey Rogers was Fishers most loyal [] pupil (Dorfman, 1969, p. 302) and became, in 1931, his colleague at Yale. It should be added, however, that Rogers analysis of the causes of the Depression was remarkably original and that he did not openly support Fishers monetary plans (cf. Rogers, 1931, 1933, 1937; Steindl, 1995, pp. 105-10). Warren (who had been one of the few to predict the deflationary process of the thirties) was a member, together with Fisher, of the advisory council of the Committee for the Nation, a pressure group whose institutional goal was to promote expansionary monetary policies. 19 The similarity with the concept of commodity dollar put forward by Fisher in the twenties is indeed striking (cf. Pavanelli, 1997). Your message to the Economic Conference, wrote Fisher in a letter to Roosevelt, makes me one of the happiest of men (Fisher, 1997, p. 61). As we know, Roosevelts message was also warmly praised by Keynes. 20 The statement by James Warburg, a prominent banker and one of the US representatives at the London conference, during a meeting of the American Academy of Political and Social Science is revealing: I do not believe that [...] anything other than a gold standard will work satisfactorily [...]; unfortunately inflationist theory was given a stimulus by the speculative rise of prices which took place in the first few months of the experiment (Warburg, 1934a, p. 146, 149. Cf. also Warburg, 1934b). 15 In practice, however, the monetary-centred policy of reflation in 1933-34 only partially achieved its aims. 21 In the second half of the thirties, most economists and the

Administration, including the Federal Reserve, came to the conclusion that monetary policy was basically ineffective and that fiscal policy measures were needed to stimulate economic recovery. Fisher realised that the open market operations promoted by the Federal Reserve had been only partially successful. His response was to promote a radical revision of the credit system, based on the abolition of fractional reserves (Allen, 1993). With this method, wrote Fisher, the circulating medium was in fact simply a by-product of the private debt, and monetary policy was unpredictable: an increase of the monetary base could bring about a sustained inflation or be almost ineffective (Fisher, 1936a, p. 105). This latter was exactly what had happened during the Depression: for fear of bankruptcy, banks had used most of the liquidity obtained from the Fed to inflate their own reserves. If the situation improved, these excess reserves could fuel a surge in inflation. 22 These dangers could have been avoided by requiring the banks to hold reserves equal to their demand liabilities (so-called 100% money) 23 In this way, financial . institutions lending function would be clearly separated from that of money creation. The central bank would thus gain full control over the money supply. Even in this case, however, monetary policy could only be effective if the velocity of money and of the demand deposits (V and V) were stable. Now, Fisher had analysed in detail these fundamental components of the equation of exchange in Purchasing Power of Money, published in 1911. The main purpose of this book, however, was to set rigorously the theoretical conditions under which the quantity 21 The Feds open market operations, adopted on a large scale only in 1932, did not bring an expansion of production but simply an increase in the reserves of the member banks. Cf. Eichengreen, 1992. 22 Unless these [huge excess reserves] are absorbed by raising the reserve requirements, they will continue to threaten us with an inflation ten times their size. These reserves were created in a vain attempt by the Fed reserve to increase business loans. A The

chief reason why the attempt failed was the partial reserve system under which the commercial banks feared to lend (Fisher, 1936b, p. 417). 23 This reform posed considerable technical problems; for example, to enable the banks to raise their reserves to the level needed, a large amount of circulating medium had to be created and distributed. These aspects will not be dealt with in the present work. 16 theory held. Fisher therefore, was basically satisfied with the assertion that in equilibrium the causes affecting the velocity of money were exogenous and specifically that both V and V were independent of the quantity of money or of deposits (respectively M and M; Fisher, 1911, p. 154). During transitions periods, on the contrary, V and V could fluctuate considerably as a consequence of changes in M and M. In 1931-32, as already mentioned, he was ready to admit that, as a consequence of widespread hoarding, the velocity of money had sharply fallen (cf. Fisher, 1932a, pp. 34-7). In the second half of the thirties, however, he gradually modified his position. In a paper presented in 1940 at the Cowles Commission he come to the conclusion that velocity of circulation was fairly constant for unspeculative accounts and maintained that the drop between 1929 and 1933 was probably much more apparent than real (Fisher, 1940; cf. Dimand, 2000. Presumably his desire to promote a reform that he considered indispensable to the stability of the economic system had induced Fisher to over-simplify his earlier position 25 . The 100% money project, which Fisher did his best to push with his usual energy (he published a monograph and several articles on this subject; see for example 1936a and 1936b), had been borrowed, as he acknowledged, from his colleagues at the University of Chicago, 26 and it marks an important turning point in his stance on monetary policy. Starting in the second half of the decade, Fisher strongly supported a policy of managed money, although limited by rules. It was necessary, he maintained in 1937 before the Committee on Agriculture and Forestry, to get rid of automatic mechanisms that had once seemed desirable, replacing them with a really managed currency (Fisher, 1937).

24 Nevertheless, Fisher did not rule out the possibility of hoarding. Taking up the device already illustrated in Stamp Scrip, he suggested attributing to the monetary authorities the power to enforce a tax on liquidity. 25 The question of whether the velocity of circulation of money is a constant or a variable, wrote Fisher in his 1940 paper, is of great importance both for monetary theory and monetary policy []. So far as monetary policy is concerned, if the velocity of circulation of money is simply a cushion for changes of quantity, any attempt to control the price level or volume of trade by controlling money would be futile (Fisher, 1940, p. 56). 26 It was first illustrated in a document of November 1933 entitled Banking and Currency Reform drawn up by Simons and signed by various Chicago economists, including Aaron Director, Paul Douglas, F.H. Knight, L.W. Mints, Henry Schultz as well as C.O. Hardy of the Brooking Institution (cf. Allen, 1993). 17 In this context he reiterated his account of the role of the gold standard in spreading the depression internationally. In the twenties Fisher, together with Keynes, had been one of the main critics of the gold standard, which he saw as unable to guarantee domestic price stability. In the thirties, he was commissioned by the International Statistical Institute to analyse the influences exercised by monetary standards on the international propagation of economic fluctuations. The results of this research, published in 1935 (cf. Fisher, 1935b), are striking and anticipate much of the research conducted in recent years (cf. Choudri-Kochin, 1980; Eichengreen, 1992). Using data from several nations in different monetary systems, Fisher demonstrated that the countries that had abandoned the gold standard earliest or that had never adopted it had performed better in output and employment and the level of prices. 27

On fiscal policy, Fisher had been very critical of the Hoover Administrations restrictive measures. Balancing the budget, he wrote in 1932, by reducing expenditures for many useful services and by extracting larger revenues from reduced income is deflationary (Fisher, 1932c). In general, however, he maintained that an expansionary monetary policy was sufficient to cure the depression and that there was no need for deficit spending: Public works, he wrote to Roosevelt in 1934, were the slowest, dearest and usually least beneficial way of dealing with the problem 28 Fisher . apparently failed to grasp the multiplier effect and interpreted the expansionary impact of deficit spending in terms of his monetary model: in order to finance public works, government had to borrow from the Federal Reserve, thus increasing the monetary base and stimulating demand. 29 27 Fisher had already made this point in 1933 in a letter to Roosevelt: It was the universal gold standard which made the depression universal, spreading the deflation infection from one country to another. Only countries not on the gold standard escaped (Fisher, 1997, p. 57). He repeated this point in 1937 during a parliamentary hearing: During the depression the cutting loose from gold by other nations helped them all. I think there is no exception. Those that were helped most were those that cut loose first. England, for instance, cut loose in 1931, France in 1936. England is now out of the depression, practically, and France is just beginning to struggle out (Fisher, 1937, p. 278). 28 Letter to F.D. Roosevelt, 11 June 1934, in Fisher, 1997, p. 83. It will require something of a wrench later, added Fisher in the same letter, to get millions of workers out of jobs under government into their normal jobs in industry. 29

Since business wouldnt borrow, the Government is borrowing [...]. Seven or [...] eight billion dollars have been re-created in this way, and thats the reason we are getting out of the depression. It isnt the spending of the Government that is doing it (the Government only 18 On the other hand Fisher vigorously opposed the New Deal measures to restrict supply and institute economic planning. In particular, he considered the initiatives to regulate wages and production as totally misguided. He firmly believed that these policies could jeopardize the results obtained by monetary measures, slowing down the recovery and prolonging the Depression. The policy of high wages, wrote Fisher, was based on the hypothesis that in this way it would be possible to create new purchasing power. The demand for labour, however, was not invariable: Wages, he wrote in 1936, are affected by supply and demand like any other price []. If you raise the price of labor arbitrarily, less labor will be bought [...]. Arbitrary mark-ups never succeed. 30 In Fishers opinion, this was why, in a context where the Depression appeared to be fading, the unemployment rate remained high. He concluded that in order to reduce unemployment, it would have been better to grant subsidized loans directly to employers, according to the number of additional workers they hired (cf. Fisher, 1997, pp. 63-4). No less severe were his objections to the policies aimed at restricting production, for the purpose of raising prices: The philosophy of limiting production is particularly out of place at present for we are suffering from too little wealth, not too much - notwithstanding popular illusions as to overproduction. We can scarcely feed the hungry more bread by destroying material of which the bread is to be made nor clothe the naked by destroying the material of which the clothes are to be made (1933c, p. 6) 31 More generally, Fisher of spends it once); but it is spent normally 25 times a year after it is once created. The Government strongly criticized the idea that the slump of the 1930s was due to structural flaws of the market economy and that it demonstrated the need

spends it, giving it to the contractor or to the people on relief, and they spend it at the store, the store gives it to the wholesaler, the wholesaler to the jobber, the jobber to the manufacturer, and the manufacturer to the laborer [...] When the Government manufacturers the money, that helps, and it is the manufacturing of this money, a by-product of debt and spending, that has gotten us out of the depression (Irving Fisher Papers, Manuscript and Archives, Yale University Library, 212, s. III, box 25, f. 396, Is a Managed Currency Workable?, cit., p. 10). 30 Irving Fisher Papers, Manuscript and Archives, Yale University Library, s. III, b. 25, f. 397, How to Secure Re-employment, New York, May 21, 1936. 31 It is interesting to observe that a similar criticism of policy measures aimed at achieving a rise in prices by reducing production was expressed by Keynes in an open letter to Roosevelt in December 1933. 19 more government in business. If my analysis [] in Booms and Depressions is correct, he wrote in 1935, the depression does not indicate a general breakdown of capitalism []. It indicates almost solely a breakdown of our monetary system (Fisher, 1935c). 5. Conclusion The events of the 1930s, writes William Barber in a recent article, presented formidable challenges for Fisher as an economic theorist [and] as an economic policy advocate (Barber, 1999, p. 25). On the eve of the stock market crash in October 1929, as mentioned, Fisher was still convinced that share prices were not overvalued and that their unprecedented increase was due to new profit opportunities created by technological innovation and sharp rises in productivity. As the depression worsened, however, he became convinced that new theoretical explanations were needed. In 1932 and 1933 he presented a new model (debt-deflation theory) based on the interaction of real and monetary aspects: starting from an initial situation of over-indebtedness, Fisher demonstrated that a minor shock could induce an explosive process characterised by reductions in the price levels and by an increase in real terms of the stock of debts. The

likely consequences were widespread failures and continuous reductions in output and employment. In Fishers opinion, this process could be stopped and reverted thanks to expansionary monetary measures: these would have increased aggregate demand and prices provided that the economic agents would have left unchanged their spending habits. During the Depression, however, there was a widespread tendency for economic agents to hoard their liquid assets; in 1932 the Yale economist became therefore an active supporter of a stamped money plan aimed at counteracting this process. During the New Deal he lobbied actively the Roosevelt Administration to support expansionary monetary measures and promoted a radical revision of the credit system aimed at abolishing fractional reserves (100% money). In the meantime he strongly opposed any governmental control on economic activity or arbitrary reductions in economic supply. 20 As a matter of fact, the dramatic events of the Depression had not shaken Fishers faith in the fundamental capacity of market economies for re-equilibrium. There was, however, one crucial exception: the money and credit system. In this case the spontaneous interaction of individual actions did not appear to be able to guarantee a stable equilibrium. Furthermore, the institutions adopted up to then, such as the gold standard and fractional banking reserves, had turned out to be sources of further disequilibrium. The consequences, given the centrality of money in the production system, had been nothing short of disastrous. The entire sector therefore had to be radically reformed and co-ordinated by government. This reform, and this alone, could provide a dependable guarantee against the recurrence of large-scale depression. References Allen, R.L. (1993), Irving Fisher. A Biography, Cambridge (Mass.), Blackwell. Allen, W.R. (1977), Irving Fisher, F.D.R., and the Great Depression, Political Economy, Vol. 9, Winter, pp. 560-587. Allen, W.R. (1997), Irving Fisher and the 100 Percent reserve Proposal, The Journal of Law and Economics, pp. 703-17. Barber, W.J. (1996), Irving Fisher as a Policy Advocate, in M. Rutherford (ed.), The Economic Mind in America: Essays in the History of American Economics, London, Routledge. Barber, W.J. (1997), Designs within Disorder. Franklin D. Roosevelt, the Economists and the Shaping of American Economic Policy, 1933-1945, Cambridge, Cambridge University Press. Barber, W.J. (1999), On Working with Irving Fishers Papers, in H.E. Loef-H.G. Monissen (eds.), The Economics of Irving Fisher, Cheltenham, Elgar. History of 21

Bernanke, B. (1995), The Macroeconomics of the Great depression: A Comparative Approach, Journal of Money, Credit and Banking, pp. 1 -28. Bernanke, B.-Gertler, M. (1990), Financial Fragility and Economic Performance, The Quarterly Journal of Economics, pp. 87-114. Blanc, J. (1998), Theory and Practice of Gesells Accelerated Money, Journal of Economics and Sociology, Oct., pp. 469-83. Brunner, K. (ed.), (1981), Nijhoff. Cargill, T.F. (1992), Irving Fisher Comments on Benjamin Strong and the Federal Reserve in the 1930s, Journal of Political Economy, Dec., pp. 1273-7. Choudri, E.U.-Kochin L.A. (1980), The Exchange Rate and the International Transmission of Business Cycle Disturbances: Some Evidence from the Great Depression, Journal of Money, Credit and Banking, pp. 565-74. Cohrssen, H. (1991), Working for Irving Fisher, Cato Journal, Winter, pp. 825-33. De Long, J.B.-A. Schleifer (1991), The Stock Market Bubble of 1929: Evidence from Closed-end Mutual Funds, The Journal of Economic History, Sept., pp. 420 -45. Dimand, R.W. (1994), Irving Fishers Debt-Deflation Theory of Great Depressions, Review of Social Economy, pp. 92-107. Dimand, R.W. (1995), Irving Fisher, J.M. Keynes and the Transition to Modern Macroeconomics, in A.F. Cottrell-M.S. Lawlor (eds.), University Press. Dimand, R.W. (2000), Irving Fisher and the Quantity Theory of Money: The Last Phase, Journal of the History of Economic Thought, n. 3, pp. 329-48. Dorfman, J. (1969), The Economic Mind in American Civilization. 1918-1933, Vol. IV, New York, A.M. Kelley. Eichengreen, B. (1992), Golden Fetters: the Gold Standard and the Great Depression, 1919-1939, Oxford, Oxford University Press. Fisher, I. (1911), The Purchasing Power of Money, New York, Macmillan. 22 Fisher, I. (1929a), Has Wall Street Gone Wild and Whirling?, Liberty, Feb. 9, pp. 61 4. Fisher, I. (1929b), Fisher doubts Market Crash, New York Times, Sept. 6. Fisher, I. (1930), The Stock Market Crash and After, New York, Macmillan. Fisher, I. (1931), Cancellation of War Debts, Southwest Foreign Trade Conference Address, July, 2. Fisher, I. (1932a), Booms and Depressions, New York, Adelphi. New Perspectives on Keynes, annual suppl. to History of Political Economy, vol. 27, Durham, Duke The Great Depression Revisited, Boston MA, Martinus American

Fisher, I. (1932b), The Depression. Causes and Cures. Address made before the Committee of One Hundred, Miami Beach, March, 1, 1932. Fisher, I. (1932c), A New Corporation formed to Salvage Securities, INI Weekly Release, June 13. Fisher, I. (1932d), Some Signs of the Time, INI Weekly Release, August 8. Fisher, I. (1933a), The Debt-deflation Theory of Great Depressions, Econometrica, pp. 337-57. Fisher, I. (1933b), Buy Now?, INI Weekly Release, August 14. Fisher, I. (1933c), Revolutionary?, INI Weekly Release, August 28. Fisher, I. (1933d), Stamp Scrip, assisted by Hans R.L. Cohrssen and H.W. Fisher, New York, Adelphi. Fisher, I. (1934a), Reflation and Stabilization, in The Annals of the American Academy of Political and Social Science, vol. 171, Jan., pp. 127-31; pp. 150-1. Fisher, I. (1934b), Rising Prices-Two Sorts, INI Weekly Release, June, 4. Fisher, I. (1935a), Unwin. Fisher, I. (1935b), Are Booms and Depressions Transmitted Internationally Through Monetary Standards? Bulletin de lInstitute International de Statistique. Fisher, I. (1935c), Government Put Deeply into Business by Debt, Waterbury, Conn., Sept. 30. Fisher, I. (1936a), 100% Money, New York, Adelphi. Fisher, I. (1936b), 100% Money and the Public Debt, Economic Forum, pp. 406-20. Fisher, I. (1937), Statement before the U.S. Congress, House of Representatives, Subcommittee of the Committee on Agriculture and Forestry, Hearings on S. 1990, a Bill for the Regulation and Stabilization of Agricultural and Commodity Prices through the Regulation and Stabilization of the Value of the Dollar, August 3, 4, 5, 10, 11, 12 and 13, 1937, 75 Cong. I Sess. Washington, Gov. Printing Office, pp. 267-90. Fisher, I. (1940), The Velocity of Circulation of Money, in Cowles Commission for Research in Economics, Report of Sixth Annual Research Conference in Economics and Statistics, Chicago, pp. 55-8. Fisher, I. (1997), Correspondence and other Commentary on Economic Policy, in Id., Works, edited by W.J. Barber assisted by R.W. Dimand and K. Foster, vol. 14, London, Pickering & Chatto. Gesell, S. (1929), The Natural Economic Order, Berlin, Neo-Verlag. Graziani, A. (1988), Il circuito monetario, il Moneta e Produzione, a cura di A. Republican, Stabilised Money. A History of the Movement, London, Allen &

Graziani e M. Messori, Torino, Einaudi, pp. xi-xliii. Keynes, J.M. (1973), Collected Writings. Vol. VII. The General Theory of Employment, Interest and Money, London, Macmillan. 23 King, M. (1994), Debt-deflation: Theory and Evidence, European Economic Review, pp. 419-45. Pavanelli, G. (1997), Il problema della stabilizzazione nel pensiero di Irving Fisher, Rivista Internazionale di Scienze Sociali, gen.-mar., pp. 49-84. Rogers, J.H. (1931), America Weighs her Gold, New Haven, Yale University Press. Rogers, J.H. (1933), The Absorption of Bank Credit, Econometrica, Jan., pp. 63-70. Rogers, J.H. (1937), Monetary Initiative in a traditional World, in A.D. G