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A Tale of Two Effects

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  • Paul Evans

    (Ohio State University)

  • Xiaojun Wang

    (University of Hawaii)

Abstract

This paper investigates the relationship between nominal interest rates and prices using nearly two centuries of data from ten industrial countries. Both a positive relationship between interest rates and price levels (that is, a positive Gibson effect) and a negative relationship between interest rates and subsequent price changes (that is, a negative Fama-Fisher effect) prevailed until World War I. We propose a simple explanation wherein this doubly paradoxical juxtaposition of effects arises when money is supplied inelastically and prices are flexible. This double paradox disappeared after World War II when economies became mostly characterized by elastic money and sticky prices. During that period, a positive Fama-Fisher effect emerged while the Gibson effect largely dissipated. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Suggested Citation

  • Paul Evans & Xiaojun Wang, 2008. "A Tale of Two Effects," The Review of Economics and Statistics, MIT Press, vol. 90(1), pages 147-157, February.
  • Handle: RePEc:tpr:restat:v:90:y:2008:i:1:p:147-157
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    References listed on IDEAS

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    1. Roll, Richard, 1972. "Interest Rates on Monetary Assets and Commodity Price Index Changes," Journal of Finance, American Finance Association, vol. 27(2), pages 251-277, May.
    2. Hafer, R W & Jansen, Dennis W, 1991. "The Demand for Money in the United States: Evidence from Cointegration Tests," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 155-168, May.
    3. Barsky, Robert B., 1987. "The Fisher hypothesis and the forecastability and persistence of inflation," Journal of Monetary Economics, Elsevier, vol. 19(1), pages 3-24, January.
    4. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    5. 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.
    6. Robert B. Barsky & J. Bradford De Long, 1991. "Forecasting Pre-World War I Inflation: The Fisher Effect and the Gold Standard," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 815-836.
    7. Dwyer, Gerald P, Jr, 1984. "The Gibson Paradox: A Cross-Country Analysis," Economica, London School of Economics and Political Science, vol. 51(202), pages 109-127, May.
    8. 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 528-550, June.
    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. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-282, June.
    11. Klovland Jan Tore, 1993. "Zooming in on Sauerbeck: Monthly Wholesale Prices in Britain 1845-1890," Explorations in Economic History, Elsevier, vol. 30(2), pages 195-228, April.
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    Cited by:

    1. Cheng, Hao & Kesselring, Randall G. & Brown, Christopher R., 2013. "The Gibson paradox: Evidence from China," China Economic Review, Elsevier, vol. 27(C), pages 82-93.
    2. Francesca Di Iorio & Stefano Fachin, 2009. "A residual-based bootstrap test for panel cointegration," Economics Bulletin, AccessEcon, vol. 29(4), pages 3222-3232.

    More about this item

    JEL classification:

    • 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
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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