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A Non-Paradoxical Interpretation of the Gibson Paradox

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  • Coulombe, Serge

Abstract

In this study, we show how, to yield the real cost of borrowing, the price level can be combined with the nominal interest rate in a monetary regime where the level of prices is trend stationary. We show that the price level then conveys intertemporal information in a way similar to nominal interest rates. We estimate real interest rate series for the gold-standard period in the United Kingdom under the assumption the agents expect the price level to come back to its long-run equilibrium value. The positive correlation between the price level and the nominal interest rate-known as the Gibson paradox and far from being paradoxical-helps explain why the nominal interest rate was so stable in a period characterized by numerous wars and important gold discoveries. The new real interest rate series provides the opportunity to re-examine Barro's (1987) finding on the effect of temporary military spending on interest rates. It also relaxes the assumption that the nominal long-term interest rate is also the expected real rate.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 98-22.

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Length: 47 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:bca:bocawp:98-22

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Related research

Keywords: Inflation: costs and benefits; Inflation and prices; Inflation targets; Interest rates;

References

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  1. David E. Lebow & John M. Roberts & David J. Stockton, 1992. "Economic performance under price stability," Working Paper Series / Economic Activity Section 125, Board of Governors of the Federal Reserve System (U.S.).
  2. Barro, Robert J, 1979. "Money and the Price Level under the Gold Standard," Economic Journal, Royal Economic Society, vol. 89(353), pages 13-33, March.
  3. Lee, Chi-Wen Jevons & Petruzzi, Christopher R, 1986. "The Gibson Paradox and the Monetary Standard," The Review of Economics and Statistics, MIT Press, vol. 68(2), pages 189-96, May.
  4. William T. Gavin & Alan C. Stockman, 1988. "The case for zero inflation," Economic Commentary, Federal Reserve Bank of Cleveland, issue Sep.
  5. Mills, Terence C., 1990. "A note on the Gibson Paradox during the gold standard," Explorations in Economic History, Elsevier, vol. 27(3), pages 277-286, July.
  6. Barsky, Robert B & Summers, Lawrence H, 1988. "Gibson's Paradox and the Gold Standard," Journal of Political Economy, University of Chicago Press, vol. 96(3), pages 528-50, June.
  7. Sumner, Scott, 1993. "The Role of the Gold Standard in the Gibson Paradox," Bulletin of Economic Research, Wiley Blackwell, vol. 45(3), pages 215-28, July.
  8. Sargent, Thomas J, 1973. "Interest Rates and Prices in the Long Run: A Study of the Gibson Paradox," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 5(1), pages 385-449, Part II F.
  9. Wicksell, Knut, 1907. "The Influence of the Rate of Interest on Prices," History of Economic Thought Articles, McMaster University Archive for the History of Economic Thought, vol. 17, pages 213-220.
  10. Corbae, Dean & Ouliaris, Sam, 1989. "A Random Walk through the Gibson Paradox," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 4(3), pages 295-303, July-Sept.
  11. Nicholas Ricketts, 1996. "Real short-term interest rates and expected inflation: Measurement and interpretation," Bank of Canada Review, Bank of Canada, vol. 1996(Summer), pages 23-39.
  12. Chen, Chung & Lee, Chi-Wen Jevons, 1990. "A VARMA Test on the Gibson Paradox," The Review of Economics and Statistics, MIT Press, vol. 72(1), pages 96-107, February.
  13. Bordo Michael D. & Kydland Finn E., 1995. "The Gold Standard As a Rule: An Essay in Exploration," Explorations in Economic History, Elsevier, vol. 32(4), pages 423-464, October.
  14. Summers, Lawrence, 1991. "How Should Long-Term Monetary Policy Be Determined? Panel Discussion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 625-31, August.
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Cited by:
  1. Alexander L. Wolman, 1999. "Real Implications of the Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 1999 1152, Society for Computational Economics.
  2. David Longworth & Brian O’Reilly, 2000. "The Monetary Policy Transmission Mechanism and Policy Rules in Canada," Working Papers Central Bank of Chile 72, Central Bank of Chile.

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