Money, Banks and Finance in Economic Thought

An inquiry into the first theories of the yield curve: Irving Fisher (1867-1947) and John Maynard Keynes (1883-1946)

Brillant Lucy, University of Bourgogne Franche Comte

The study of the term structure of interest rates is relatively new in the field of economics. It has become a sub-discipline in economics since the sixties. Many empirical researches are devoted to it by now . Although Keynes and Fisher are known to have elaborated a first version of this theory (Dimand and Gomez Betancourt, 2012), literature expressed little interest in the understanding of the context in which their theories emerged. Fisher, particularly, has not received much attention, even if he is known to be the founder of the theory of the yield curve. He gave a first version of this theory before the date of birth of the Federal Banking System. This article analyses and gives a context of the firsts theories of the term structure of interest rates which emerged first in the United-States (1896), and then in England (1930). Fisher and Keynes presented different factors connecting short and long-term interest rates. Fisher described a structure of markets, coming from time preferences of agents present on financial markets. Arbitragers, taking profit of this structure, flatten the term structure of interest rates. There is an absence of opportunity of arbitrage. While for Keynes, expectations depend on many factors: in normal times on the future monetary policy, and rather on market feelings. But the term structure never become flat in Keynes’s writings, because of risks in the activity of arbitrage. The nature of interest rates are different in Fisher and Keynes’s thoughts. Contrary to Fisher, in which interest rates represent time preferences, Keynes seems to present interest rates as the price of liquidity. The first part of this paper gives evidence that Fisher did not integrate expectations on future monetary policy in his theory of interest rates, from his first to his last writings about this issue (1896 and 1930). However it does not prevent him from developing the theory in 1896, where time-preference and the purchasing power of money are determinant (this will be studied in the second part). In spite of his strong interest for monetary plans, and the need to stabilize the value of money in the United-States, Fisher’s theory did not influence much the economists of the Board of governors of the Fed, as seen in the third part. In the twenties, the Fed discovered a new liquidity channel through the coordination of open-market purchases. This (third) part is about the growing use of open-market operations to control the liquidity of the money market in the United-States, and the absence of those operations in Fisher’s theory of the term structure of interest rates. The fourth part deals with the reception in England of those American monetary discoveries. Keynes wanted to break with traditional monetary policies aiming at defending the stock of gold. He developed a theory of the term structure of interest rates in which the central bank should influence the long-term rate, which could, in turn, affect new investments.


Keywords: arbitrages, expectation, purchasing power of money, yield curve

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