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Devolution of the Fisher Equation: Rational Appreciation to Money Illusion
James R. Rhodes National Graduate Institute for Policy Studies June 16, 2008 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 Fishers theory of money illusion.
Keywords: Fisher equation, Fisher hypothesis, Fisher effect, money illusion, nominal interest rate, purchasing power of money, value of money JEL Classifications: E40, B00, B31 Working Paper SeriesDate posted: June 08, 2006 ; Last revised: June 16, 2008Suggested CitationContact Information
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