Irving Fisher

“ To the extent that such changes come unexpectedly after loan contracts have been entered into which take no account of them,—to that extent loan contracts are speculative. If incomes fall, the lender has gained relatively to the borrower, because he has realized a higher interest than he could have realized had the change been foreseen. The chief burden of the change falls on the borrower. If incomes experience an unexpected rise, the relative positions are reversed; the whole gain goes to the borrower. The normal effect of continuous extension of income is to raise the rate of interest. ”

“ To repay the same amount of purchasing power over shelter as was borrowed is to repay less than the same amount of purchasing power over houses. The borrower is benefited to the extent that he has to curtail investments to repay, since he repays a less investing power although as great a spending power. He need not, therefore, curtail his investments in land and machinery quite so much as he otherwise would have to do. The lender, on the other hand, is in the same degree injured. ”

“ If we take hours of labor as the basis and measure the wages paid by the hour or by the day, then we are likely to find that, during a period of improvement in the arts, money wages are rising while the prices of goods are falling, or that money wages are rising faster than the prices of goods, or are falling more slowly. But if we measure wages by the piece, we shall find less inconsistency of results. If goods increase faster than currency, so that prices tend to fall, piece wages will tend to fall, on the average, in very much the same proportion. ”

“ It was seen to be not an infringement of justice that one man should gain from another on account of fluctuations in the money standard; for the contract is a free one in which normally each should assume whatever risk there may be of loss for the sake of whatever chance there may be of gain. ”

“ In the first place, the situation interferes with the normal distribution of wealth and income. If the level of prices is rising, since nominal interest does not for a considerable time rise enough to compensate, the lender gets back a less amount of wealth or services than he might reasonably have expected. Creditors lose and debtors gain. It should be noted also that all persons with relatively fixed money salaries lose by this rise of prices. When the level of prices falls, on the other hand, creditors and persons with relatively fixed incomes gain at the expense of debtors. ”

“ One way to obtain an index of real wages is to correct the nominal or money wages by using the index number of prices of goods for which wages are spent. Thus, if money wages for 1908 were twice those for 1900, but money prices of the necessaries and comforts of life had also doubled, real wages would be unchanged.
X.26 Evidently the index numbers used in the case of quantities and prices of workmen's living are not the same as those used in the case of capital. Goods should have each an importance in the index number, dependent upon its importance in workingmen's budgets. ”

“ The goods which interested a lender in any given case might not be those of most importance to the borrower. Only a rough average could be struck and an index number found to be used by all parties in their contracts. Such an average would doubtless be one in which each price ratio would be weighted according to the total consumption of the goods to which it related,—the total consumption of all borrowers and all lenders in the country considered. ”

“ Then the lender really gains, since he can now get more of other goods in exchange for those it was his original purpose to use,—a course which he may now be tempted to take while otherwise he would not. To the borrower, however, the appreciation of the goods on the basis of which repayment is made, relatively to the goods he is engaged in producing, might be regarded as causing him loss. The same purchasing power over the goods, on the basis of which he is to make payment, means in such a case, a greater purchasing power over the goods he is engaged in producing. ”

“ With higher interest, the value of land, railroads, and other durable capital will be lower because the value depends on future earnings or future services, and these are now discounted at a higher rate.*36 The borrower, in paying back an equal purchasing power over consumable goods and services, is paying back a much higher purchasing power over such things as land, houses, and factories—a much higher purchasing power over future income—than he borrowed. ”

“ X.59 Somewhat similar theories of a perfect standard of deferred payments are based on the idea that a dollar should require always the same amount of labor to produce it. In one sense, since marginal utility and marginal effort are normally equal, the labor standard is identical with the marginal utility standard. But in whatever sense "labor" is defined, it is an elusive magnitude, quite impracticable as a measurable basis for statistics of purchasing power. ”

“ If the purpose is to measure capital, the prices of services should not be included, but only the prices of the different articles of wealth existing at any point of time. If the purpose is to obtain means to measure real wages, only those things should be included which workingmen buy; and they should be included according to the values bought during a given period, these values being measured at standard prices.
X.80 The question of justice between borrower and lender, where the purpose is to fix on the best index number as a standard for deferred payments, was also considered. ”

“ It is true that retail prices usually lag behind wholesale prices; but part of the lagging is more apparent than real. Expert testimony of those who have collected such statistics shows that when, as at present, prices are rising rapidly, retailers obviate the necessity of confronting their customers with too frequent and rapid increases in prices by quoting the same prices and substituting inferior grades or, in some instances, smaller loaves or packages. ”

“ If the average income is rising, the borrower can afford to repay more and the lender should receive more; while, if the average income is falling, the amount paid should be less. The fact is that such are the tendencies where the rise or fall of average income is foreseen. If the average income is rising, the lender will be less anxious to deplete his present income, which is relatively meager, in order to increase his future income, which he sees will probably be larger anyway. ”

“ But, although in the science of optics we learn that a perfect lens is theoretically impossible, nevertheless, for all practical purposes lenses may be constructed so nearly perfect that it is well worth while to study and construct them. So, also, while it seems theoretically impossible to devise an index number, P, which shall satisfy all of the tests we should like to impose,*20 it is, nevertheless, possible to construct index numbers which satisfy these tests so well for practical purposes that we may profitably devote serious attention to the study and construction of index numbers. ”

“ Borrowers and lenders, in other words, may be more interested in purchasing factories, railroads, land, durable houses, etc., which yield services during a long future, than in purchasing more or better food, shelter and entertainments, which yield immediate satisfactions. ”

“ From a practical standpoint, wholesale prices of commodities are the only prices which are yet sufficiently standardized, and the use of the goods sufficiently stable through a long period of time, to make them serviceable for general use.
X.70 Not only may we consider that wholesale prices roughly represent all prices, but we may, with even more confidence, confine our statistics for wholesale prices to a relatively small number. Edgeworth and others have shown, both practically and theoretically, that a large number of articles is needless and may even be detrimental. ”

“ X.12 We choose, then, as one of the best index numbers of prices, the average price of the goods sold, those goods being measured in units worth a dollar in the base year; in other words, the ratio of the value of sales at actual prices to the value of the same sales if made at base prices; in still other words, the weighted arithmetical average of all price ratios, each ratio being weighted according to the values sold, reckoned at base prices. ”

“ X.61 It will also simplify our problem if we remember that our ideal is not primarily constancy of the dollar but rather dependability. Fluctuations which can be foreseen and allowed for are not evils. Each man may presumably be depended on to allow for changes in his own fortunes, utility, and labor, and perhaps even to a large extent on the general effects of invention and progress. ”

“ We may obtain the price index first and then obtain a quantity index by dividing the value of capital in any year by the price index, or we may proceed in the reverse direction.*27 In making index numbers of prices of capital and quantities of capital, we naturally select for our list articles which are important as capital, and weight them accordingly. ”

“ X.43 Instead, therefore, of basing our index number on consumable goods and services enjoyed during a period, we ought rather to base it partly on these and partly on the amount of durable capital. Each borrower and each lender may wish to make a different distribution in time of his income stream.*37 One man, that he may have a large income in the future, wants to invest; another, that he may enjoy a large income soon, does not want to invest. One lender is, therefore, interested in getting back as much durable capital as he lent ”

“ The volume of piece work increases with progress in invention faster than the volume of time work.
X.51 In considering the index number as a standard for deferred payments, the desirability of assuming piece wages to change like commodity prices is based largely on the difficulty and consequent impracticability of including wages on a time basis. On the piece-wage basis, changes in money prices of other goods furnish an approximate measure of changes in money prices of labor. ”

“ In this case each ratio should be weighted, not according to the annual sales, but according to the existing capital. Obviously, the difference between these two modes of weighting may be great. Thus, real estate forms a large part of all existing capital, but sales of real estate are a relatively unimportant part of all sales. Food products, on the other hand, contribute little to capital and much to exchange. Consequently, prices and quantities of food products would not figure in capital index numbers, but would figure largely in the index numbers relating to the equation of exchange. ”

“ X.25 If the income of workingmen is under consideration, we have to deal with index numbers for prices of those goods entering into workingmen's budgets, and with index numbers of the quantities of such goods. The first will show the cost of living of the workingman, or the purchasing power of a workingman's dollar ”

“ But, aside from the practical difficulties of measuring such subjective magnitudes—which are insuperable and therefore render their discussion purely academic—there are even more serious theoretical objections because of the fact that the standard would increase with some persons and decrease with others as they grow poorer or richer and that these changes are anticipated in making loan contracts—in fact, are the instigating causes of such contracts. ”

“ X.31 Indeed, for a government to attempt by legislation to deprive the gainer of his profit would itself be in general unfair.*29 To protect themselves from losses the risk of which they took upon themselves, the losing parties cannot justly betake themselves to legislation after the making of contracts. ”

“ It also has the advantage of easily exhibiting (by means of the "quartiles") the tendency to dispersion of prices (from each year as a base to the next) on either side of the median. The median should be weighted in round numbers analogously to the weighting already discussed for the more theoretically perfect index numbers.*52 The median of a series of numbers is a number such that there are as many numbers above as below it in the series. If the number of terms in the series is odd, the median is the middle term of the series of numbers arranged in the order of magnitude. ”

“ X.39 The case is even more complicated, however; for many borrowers and lenders are interested less in consumption than in investment.*35 The choice is as much between lending and other investing as between lending and consuming. Similarly, the borrower may borrow to invest as well as to consume and may raise the money for repayment by curtailing investment rather than by curtailing consumption. ”

“ X.6 There are innumerable methods of weighting*19 and of averaging. None of them is perfectly satisfactory from a theoretical standpoint. We must choose what seems to be best from a practical standpoint. The effect of changed volume of currency or changed velocity of circulation on the whole series of prices is complex, and cannot, even in theory, be compressed into one figure representing all price changes, any more than a lens can be constructed which will focus in one point all the rays of light reaching it from a given point. ”

“ Suppose, for instance, that we wish to measure changes in the general level of prices of capital goods,*26—railways, ships, real estate, etc.,—and also to measure the relative changes in the amounts of those goods. The prices of some kinds of capital may have increased, and of others decreased, and some may have increased at different rates from others. ”