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Was the Gibson Paradox for real? A wicksellian study of the relationship between interest rates and prices

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  • Chadha, Jagjit S.
  • Perlman, Morris

Abstract

We examine the relationship between prices and interest rates for seven advanced economies in the period up to 1913, emphasizing the UK. There is a significant long-runpositive relationship between prices and interest rates for the core commodity standard countries. Keynes (1930) labelled this positive relationship the Gibson Paradox. A number of theories have been put forward as possible explanations of the Paradox but they do not fit the long-run pattern of the relationship. We find that a formal model in the spirit of Wicksell (1907)and Keynes (1930) offers an explanation for the paradox: where the need to stabilize the banking sector’s reserve ratio, in the presence of an uncertain natural rate, can lead to persistent deviations of the market rate of interest from its natural level and consequently long run swings in the price level.

Suggested Citation

  • Chadha, Jagjit S. & Perlman, Morris, 2014. "Was the Gibson Paradox for real? A wicksellian study of the relationship between interest rates and prices," Economic History Working Papers 56896, London School of Economics and Political Science, Department of Economic History.
    • Handle: RePEc:ehl:wpaper:56896
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    References listed on IDEAS

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    1. 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.
    2. Bordo, Michael D. & Schwartz, Anna J., 1999. "Monetary policy regimes and economic performance: The historical record," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 3, pages 149-234, Elsevier.
    3. Muscatelli, Vito Antonio & Spinelli, Franco, 1996. "Gibson's Paradox and Policy Regimes: A Comparison of the Experience in the US, UK and Italy," Scottish Journal of Political Economy, Scottish Economic Society, vol. 43(4), pages 468-492, September.
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    6. Michael D. Bordo, 1995. "The Gold Standard as a `Good Housekeeping Seal of Approval'," NBER Working Papers 5340, National Bureau of Economic Research, Inc.
    7. 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.
    8. Shiller, Robert J & Siegel, Jeremy J, 1977. "The Gibson Paradox and Historical Movements in Real Interest Rates," Journal of Political Economy, University of Chicago Press, vol. 85(5), pages 891-907, October.
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    Cited by:

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    More about this item

    Keywords

    Gibson’s paradox; Keynes-Wicksell; prices; interest rates;
    All these keywords.

    JEL classification:

    • B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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