Irving Fisher and Interst Rate Determination

The Essence and Significance of his Rate of Interst

Abstract

Irving Fisher's interest theory presented in Rate of Interest (1907) is known by his time preference theory which focuses on the decision-making related to two points in the time.
However, his interest theory is based on period, rather than instantaneous, analysis. In this sense, Fisher's theory of interest differs from Böhm-Bawerk's “continuous input and instantaneous output” interest theory, assuming instead “continuous input and continuous output” model. This is an important originality of his interest theory.
Fisher's interest theory is divided into three “approximations”. In the first approximation, he presents conditions for the determination of interest rate under the supposition of a single income stream. In the second approximation, considering alternative income streams, he devises the rate of return over cost. In the third approximation, uncertainty is introduced.
The conception of uncertainty in Rate of Interest is a theoretical link to Fisher's Appreciation and Interest (1896) and Purchasing Power of Money (1911), since in these later writings, imperfect foresight under uncertainty plays an important role. In this sense, Rate of Interest is a cornerstone for creation of a macro-dynamic, rather than a micro-static, theory.