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

Published online by Cambridge University Press:  28 July 2014

Jagjit S. Chadha  and
Morris Perlman
Jagjit S. Chadha*
Affiliation:
University of Kent
Morris Perlman
Affiliation:
London School of Economics
*
Corresponding author: Jagjit Chadha, Chair in Banking and Finance, School of Economics, University of Kent, Canterbury, UK, CT2 7NP, jsc@kent.ac.uk and jagjit.chadha@econ.cam.ac.uk.
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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.

Keywords

Gibson's ParadoxKeynes–Wicksellpricesinterest rates

JEL classification

B22: Macroeconomics E31: Price Level • Inflation • Deflation E42: Monetary Systems • Standards • Regimes • Government and the Monetary System • Payment Systems E12: Keynes • Keynesian • Post-Keynesian
Type
Articles
Information
Financial History Review , Volume 21 , Issue 2 , August 2014 , pp. 139 - 163
Copyright
Copyright © European Association for Banking and Financial History e.V. 2014 

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