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Born in Stockholm, Sweden, 1851 Son of a successful businessman and
real estate broker Orphan at the age of 15 Mathematics and Physics 1887: Economics 1898: Interest and Prices 1916: Swedish government advisor on
financial and banking issues main intellectual rival was the American
economist Irving Fisher
Interest and Prices
natural rate of interest vs. money rate of interest
real profit (r)
MPK
money market (i)
Cumulative Process model
MPK > i I > S M rises
Demand > Supply prices rise The demand for loans will continue accumulating, and the banking system's deposit
creation continues indefinitely - with savings never really catching up. Money supply will expand endogenously without limit and prices will also rise without end.
Born in New York, 1867Born in New York, 1867 Yale UniversityYale University
• 1888: B.A.1888: B.A.• 1891: Ph.D.1891: Ph.D.
Mathematics & EconomicsMathematics & Economics 1930: 1930: The Theory of InterestThe Theory of Interest
The Theory of Interest:The Theory of Interest:As determined by the As determined by the
impatience to spend income impatience to spend income and and
opportunity to invest it.opportunity to invest it.
IncomeIncome CapitalCapital InterestInterest
Income Income
3 stages:3 stages:• Psychic income or enjoyment incomePsychic income or enjoyment income• Real incomeReal income• Money income or cost of livingMoney income or cost of living
real incomereal income
The Thames below WestminsterThe Thames below Westminsterabout 1871about 1871
Oil on canvas 47 x 72.5 cm. Oil on canvas 47 x 72.5 cm.
CapitalCapital
““The value of any property, or rights to wealth, is its value The value of any property, or rights to wealth, is its value as a as a source of income source of income and is found by discounting that expected and is found by discounting that expected income” (Fisher, 1930, p.14).income” (Fisher, 1930, p.14).
the value of capital is the present value of the flow the value of capital is the present value of the flow of (net) income that the asset generatesof (net) income that the asset generates
any asset that produces a flow of income over timeany asset that produces a flow of income over time
Capital goods Income
Income valueCapital value
Rate of InterestRate of Interest
capital value X capital value X rate of interestrate of interest = interest = interest
(a) the time preference people have for consuming today versus consumption at a later time, and
(b)the expectation that income saved and invested today will yield greater income tomorrow – capital produced today will generate greater future production than was required to construct the capital
IMPATIENCE
OPPORTUNITY
Difference between Classical Difference between Classical economists and Irving Fishereconomists and Irving Fisher
According classical economists there are four According classical economists there are four sources of income:sources of income:
• RentRent• WagesWages• ProfitsProfits• InterestInterest
Fisher treated interest not as a separate entity of Fisher treated interest not as a separate entity of income, but as sub-entity within each of the 3 income, but as sub-entity within each of the 3 sources of incomesources of income
Other non-economic factors that Other non-economic factors that influence rate of interest:influence rate of interest:
Foresight - intelligenceForesight - intelligence Self-control – willingnessSelf-control – willingness HabitHabit Life ExpectancyLife Expectancy The love of one's childrenThe love of one's children FashionFashion
Fisher, Irving. The Nature of Capital and Income. New York: The Macmillan Company, 1906.
Octavo, 1st edition in original green cloth. $1600.Source: http://www.manhattanrarebooks.com/fisher.htm
Born in Cambridge, 1883Born in Cambridge, 1883King's College, CambridgeKing's College, Cambridge
Mathematics in 1905Mathematics in 1905Alfred Marshall and Arthur PigouAlfred Marshall and Arthur Pigou
1936: 1936: General TheoryGeneral Theory1942: was made a lord1942: was made a lord1944: Bretton Woods Conference1944: Bretton Woods ConferenceApril 21, 1946 passed awayApril 21, 1946 passed away
General TheoryGeneral Theory““Liquidity-preference”Liquidity-preference”
iIlliquid assets Liquid assets
Financial wealth
Wealth is allocated between liquid and illiquid assetsWealth is allocated between liquid and illiquid assets
“ “Thus the rate of interest at any time, being the Thus the rate of interest at any time, being the reward for parting with liquidity, is a measure of the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part unwillingness of those who possess money to part with their liquid control over it. The rate of interest is with their liquid control over it. The rate of interest is not the “price” which brings into equilibrium the not the “price” which brings into equilibrium the demand for resources to invest with the readiness to demand for resources to invest with the readiness to abstain from present consumption. It is the “price” abstain from present consumption. It is the “price” which equilibrates the desire to hold wealth in the which equilibrates the desire to hold wealth in the form of cash with the available quantity of cash; — form of cash with the available quantity of cash; — which implies that if the rate of interest were lower, which implies that if the rate of interest were lower, i.e. i.e. if the reward for parting with cash were if the reward for parting with cash were diminished, the aggregate amount of cash which the diminished, the aggregate amount of cash which the public would wish to hold would exceed the available public would wish to hold would exceed the available supply, and that if the rate of interest were raised, supply, and that if the rate of interest were raised, there would be a surplus of cash which no one would there would be a surplus of cash which no one would be willing to hold.” (Keynes, 1936).be willing to hold.” (Keynes, 1936).
Money Demand TheoryMoney Demand Theory
People hold money for three reasons:People hold money for three reasons:
► Transaction MotiveTransaction Motive► Precaution MotivePrecaution Motive► Speculation MotiveSpeculation Motive UncertaintyUncertainty
Expectation
On expectationOn expectation
► If E(If E(ΔΔii) > 0 ) > 0 M Mdd > 0 > 0
► If E(If E(ΔΔii) < 0 ) < 0 M Mdd < 0 < 0
Md (E(E(ΔΔii))))
Interest Rate is a function of money demand and Interest Rate is a function of money demand and money supply; it is a monetary factormoney supply; it is a monetary factor
ii* * = = ii (M (Mdd, M, Mss))
Sir John HicksSir John Hicks
Born in 1904 at Warwick, EnglandBorn in 1904 at Warwick, England MathematicsMathematics Clifton College (1917-22) Clifton College (1917-22) Balliol College, Oxford (1922-26)Balliol College, Oxford (1922-26) 1937: IS-LM model1937: IS-LM model
IS-LM modelIS-LM model
Based on John M. Keynes’s Based on John M. Keynes’s General TheoryGeneral TheoryAll equilibria in both commodity and money All equilibria in both commodity and money
marketsmarkets
IS curve: IS curve: Y = fY = f((ii) ) equality of S and I equality of S and I LM curve: LM curve: ii = = ff((YY) ) equality of Ms and Md equality of Ms and Md
In 1982 Hicks rejected this model because although In 1982 Hicks rejected this model because although it is a very useful apparatus to understanding it is a very useful apparatus to understanding Keynes’ Keynes’ General Theory General Theory but it lacks one very but it lacks one very essential thing that Keynes already knew:essential thing that Keynes already knew:
Uncertainty