Saturday, May 27, 2017

Fisher's Theory of Interest #2

As said in my previous post, Irving Fisher regarded income as the central concept of economics. For much of the spending of income, or the cost of living, there is little time difference between expenditure and its enjoyment or use. For example, there is little difference between buying a movie ticket and seeing the movie, paying the monthly rent and having a place to live, buying food and eating it.

The time difference worth noting is that when money is spent not simply for a short-term use, but for all its possible future uses.  If a house is bought, we do not count the purchase price as all spent for this year's shelter. We expect to live in the house for years. Only a portion of the purchase price is regarded as the cost of the current year's use. The same applies to other durable goods such as an automobile, and most furniture and appliances. The true real annual income from such goods is the approximate equivalent of the cost of services they give each year.

Fisher said nothing about a home mortgage, car loan or car lease. This was likely due to their being uncommon when he wrote this more than a century ago. In any case, his focus was on money payments for consumption goods, or money outgo. Money income includes all money received whether spent or not. The part of money income not spent is saved or reinvested.

Several pages later Fisher says capital gains are not income. That seemed odd initially. Maybe he meant unrealized capital gains are not income, and he would have regarded realized capital gains as income. He did not use the italicized words, but they fit an example he gave. It was about a bond, whose price grows with accrued interest between coupon dates. "That growth in its value is not income but increase in capital. Only when the coupon is detached does the bond render, or give off, a service, and so yield income" (The Theory of Interest, p.26). The phrase "the coupon is detached" is archaic (link). Substitute "interest is received" to modernize it.

"If Henry Ford receives $100,000,000 in dividends but reinvests all but $50,000, then his real income is only $50,000, even if his money income is $100,000,000. And if he ...  received no dividends and yet spent $40,000 in that year for living expenses and all other satisfactions, then his real income was this $40,000 even if his money income that year was zero.
   "Thus the income enjoyed in any year is radically different from the ups and down of ones capital value in that year--whether this is caused by savings or the opposite, or by changes in the rate of interest or by so-called chance" (The Theory of Interest, p.27).


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