Comments on John Geanakoplos's “The Ideal Inflation‐Indexed Bond and Irving Fisher's Impatience Theory of Interest with Overlapping Generations”

It is refreshing to hear an account of Irving Fisher's views on risk and indexation juxtaposed with an account of our modern concerns with the same issues. It is interesting for me to hear this, partly since it shows that many of the issues we worry about today were concerns 70 or more years ago, and thus perhaps that these issues are indeed as deep and fundamental as we now think they are. But I found this history-of-thought presentation most interesting because it clarifies, by starting with simple notions that were on Irving Fisher's mind and moving forward, some of the critical issues concerning the innovations of indexation and Social Security reform. John's paper with Martin Shubik (1990), described here, is really a deep theory of indexation, a theory that I think Irving Fisher wanted to have but could not get with the theoretical apparatus of his day. As evidence that Fisher wanted this, I show a few quotes from his 1911 book, The Purchasing Power of Money. Irving Fisher appreciated that index number theory is a central issue for economists because it will be applied to the specification of intertemporal contracts: Perhaps the most important purpose of index numbers is to serve as a basis of loan contracts. (1911: 208) I would put this as saying that since index numbers have their most important application in long-term contracts, index number theory ought to be considered a topic in theoretical finance. Fisher also appreciated that indexation of contracts is not something that should be thought of as an issue of "fairness" or "justice," even though much of the debate about it today tends to be put in these terms. Discussions of the importance of indexed bonds speak of the unfairness of a situation in which the real value of a debt has been eroded by inflation. Discussions today of Social Security reform and the indexation of benefits also often center on doing the fair or just policy toward Social Security beneficiaries. But instead, the issue should be how indexed contracts as part of a portfolio strategy, or social risk-sharing strategy, can be used to promote a broader purpose of real risk management for all parties. Fisher wrote: In the first place, it should be pointed out that though there is a gain or loss [on loan contracts due to unexpected price changes] there is not necessarily any "injustice" wrought because of a change in the level of prices. ... Each party knew or should have known that the price level might change, and took the risk. (1911: 209) Fisher, in his many researches on index numbers, was struggling with the central difficulty of defining an indexed contract that will be useful at large for contracts when there are many goods: Suppose, for example, that a lender receives back purchasing power over an amount of goods of the kinds he wished to use, equivalent to that he lent plus interest. Suppose also that, during the period of the loan, these goods appreciate relatively to others. 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.... To the borrower, however, the appreciation of the goods the basis of which repayment is made, relatively to the goods he is engaged in producing, might be regarded as causing him a loss. The same purchasing power over the goods, on the basis of which he is to make repayment, means in such a case, a greater purchasing power over the good he is engaged in producing. It is clear that no one kind of goods is a fair standard. An index number intended to serve as a standard for deferred payments must have a broad basis. (1922: 212-213) In this connection it may be well to call attention to another standard of purchasing power of money which has sometimes been suggested for adjusting contracts. This is the utility standard. …