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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, emphasising the UK. There is a significant long-run positive relationship between prices and interest rates for the core commodity standard countries. Keynes ([1930] 1971) 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] 1971) offers an explanation for the paradox: where the need to stabilise 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," Financial History Review, Cambridge University Press, vol. 21(2), pages 139-163, August.
    • Handle: RePEc:cup:fihrev:v:21:y:2014:i:02:p:139-163_00
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    References listed on IDEAS

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    1. 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.
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    4. Hakan Berument & Ezequiel Cabezon & Richard Froyen, 2017. "A century and three-quarters of Bank Rate and long-term interest rates in the United Kingdom," International Finance, Wiley Blackwell, vol. 20(1), pages 26-47, March.

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    More about this item

    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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