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Endogenous versus exogenous money: the unnoticed implications of Irving Fisher’s 100% money proposal for the quantity theory

Demeulemeester Samuel, ENS de Lyon and Paris 8 University

In The Purchasing Power of Money (1911), Irving Fisher sought to reinstate the quantity theory of money (QTM). Including transferable bank deposits (M’) alongside lawful money (M) in the equation of exchange, he tried to demonstrate that, ceteris paribus, any change in the general price level (P) had necessarily to be caused by a corresponding change in M. This interpretation, however, rested on the fundamental assumption that the M’/M ratio was constant—which, Fisher noted, was true only in the long run. In the short run (i.e. in “transition periods”), on the contrary, this ratio was constantly moving, seeking a new equilibrium position. The main factor responsible for such instability, in his view, was the behaviour of the rate of interest, the adjustment of which always lagged behind the variations of P—an explanation that Fisher would tend to keep in his monetary writings. He would, in parallel, keep advocating various schemes to stabilize the price level, until, in 1935, he took up the Chicago Plan idea of imposing 100% reserves behind transferable bank deposits—which he would term the “100% money” plan. This proposal has usually been regarded—including, in our view, by Fisher himself—above all as a practical solution to achieve price level stability, in an otherwise unchanged theoretical framework. We argue, however, that far from being just a practical scheme, the 100% money idea conveyed important new theoretical elements. In particular, the main cause of the short-run instability of money no longer was the lag of the interest rate; it was now what Fisher called “the tie between money and debt”. We argue that this should have led him to revise his interpretation of the QTM, by distinguishing between a system of endogenous money creation by the banks, in which the variations in M’ and P mutually fed upon each other, and a system of fully exogenous money creation by the state, in which the causality became unidirectional (from M to P), even in the short run.

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Keywords: Irving Fisher, Quantity theory, 100% money, Chicago Plan

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