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Giovanni Pavanelli

Dipartimento di Scienze Economiche e Finanziarie “G. Prato”

Università di Torino

December 2001


This paper offers a critical re-examination of Fisher’s 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 Roosevelt’s 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.

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 (debt-
deflation 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.

This paper offers a critical re-examination of Fisher’s 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 economist’s academic
credibility as well as public trust in his analyses1.
Yet Fisher’s 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 Fisher’s 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,

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.

therefore, expectations of considerable increases in production and profits2. 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
debts4, and to radically review American customs policy, abolishing the 1930 Smoot-
Hawley 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

In Fisher’s 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).
This stimulating even if controversial thesis has been rediscovered by recent literature
(cf., among others, Sirkin, 1975; De Long-Schleifer, 1991).
“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).

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 reduction5. 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

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).
“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,
“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).

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, over-
indebtedness, 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

In Booms and Depression Fisher clarified that in reality the relationships between
these phenomena were more complex.
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
Fisher’s 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
prevail over that of Pigou (Tobin, 1980). Moreover, in Fisher’s analysis the supply side plays an
important role. According to Fisher, the debtor’s 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

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 today’s 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 debt-
deflation 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 Reserve’s 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, 1934a10; 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.
“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).

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 Fisher’s 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, Fisher’s 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

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).
Irving Fisher Papers, Manuscript and Archives, Yale University Library, s. III, b. 25,
f. 396, Is a Managed Currency Workable? An Address to the Commerce Club, Chicago, Ill.,
Feb. 28, 1936, p. 10.

other words, induces an increase in aggregate demand, which in turn pushes prices
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 Booms and Depressions14. 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”.
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

“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).
“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).
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, The Natural Economic Order, translated into English in 1929 (Gesell, 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

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
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

Naturally, this presupposes that “stamped money” was accepted as money by all
agents as a group.
“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).

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, banker’s 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 Fisher’s 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.

4. Fisher’s 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

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 1933-
34 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 Roosevelt’s monetary policy
measures, in the first place on his decision to suspend the gold standard. Fisher’s
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-à-vis the currencies that used
the gold standard) with the aim of raising the prices of goods (cf. Warren-Pearson,

Interestingly, Roosevelt’s two most influential monetary experts, the economists
James Harvey Rogers and George Warren, were both linked to some degree to Fisher. Harvey
Rogers was “Fisher’s 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 Fisher’s 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.
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, Roosevelt’s message was also warmly praised by Keynes.
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).

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
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 The
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

The Fed’s 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.
“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 chief
reason why the attempt failed was the partial reserve system under which the commercial banks
feared to lend” (Fisher, 1936b, p. 417).
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.

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 position25.
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).

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.
“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).
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).

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 Administration’s
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 problem28. 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

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).
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”.
“Since business wouldn’t borrow, the Government is borrowing [...]. Seven or [...]
eight billion dollars have been re-created in this way, and that’s the reason we are getting out of
the depression. It isn’t the spending of the Government that is doing it (the Government only

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 Fisher’s 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 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 of

spends it once); but it is spent normally 25 times a year after it is once created. The Government
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).
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.
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.

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,

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 Fisher’s 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.

As a matter of fact, the dramatic events of the Depression had not shaken Fisher’s 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.


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