Income Measurement and the Fisher Equation: Apples and Oranges when Converting from Nominal to Real Terms!

35 Pages Posted: 19 Mar 2011 Last revised: 26 Aug 2015

See all articles by Niklas Lampenius

Niklas Lampenius

University of Hohenheim - Faculty of Business, Economics and Social Sciences

Daniel Kiechle

University of Hohenheim

Date Written: August 24, 2015

Abstract

We evaluate the well-known Fisher Equation in the context of accounting income with a focus on its implicit assumptions regarding capital maintenance. Our findings indicate that the Fisher Equation does not allow for a consistent conversion from nominal to real terms, given that it modifies the capital maintenance assumption inherent in nominal income. As a consequence, periodic income figures, and the resulting possible consumption patterns, are not equivalent in both standards. We find this inacceptable when dealing with accounting income, since the definition of income is modified through the conversion and, thus, the intention of standard setters. To resolve this issue we formulate a generalized version of the Fisher Equation that captures capital maintenance explicitly and allows for a consistent conversion. The Generalized Fisher Equation provides a parsimonious framework to convert nominal [real] terms to real [nominal] terms without tempering with the underlying capital maintenance assumptions.

Keywords: Measurement of Income, Fisher Equation, Capital Maintenance, Inflation, Real Rate of Return, Nominal Rate of Return, Theory of Interest

JEL Classification: M40, E31, E40

Suggested Citation

Lampenius, Niklas and Kiechle, Daniel, Income Measurement and the Fisher Equation: Apples and Oranges when Converting from Nominal to Real Terms! (August 24, 2015). Available at SSRN: https://ssrn.com/abstract=1788206 or http://dx.doi.org/10.2139/ssrn.1788206

Niklas Lampenius

University of Hohenheim - Faculty of Business, Economics and Social Sciences ( email )

Stuttgart, 70593
Germany

Daniel Kiechle (Contact Author)

University of Hohenheim ( email )

Fruwirthstr. 48
Stuttgart, 70599
Germany

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