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A Non-Paradoxical Interpretation of the Gibson Paradox

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  • Serge Coulombe

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.

Suggested Citation

  • Serge Coulombe, 1998. "A Non-Paradoxical Interpretation of the Gibson Paradox," Staff Working Papers 98-22, Bank of Canada.
    • Handle: RePEc:bca:bocawp:98-22
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    Cited by:

    1. Binder, Carola Conces, 2016. "Estimation of historical inflation expectations," Explorations in Economic History, Elsevier, vol. 61(C), pages 1-31.
    2. Steve Ambler, 2009. "Price‐Level Targeting And Stabilisation Policy: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 23(5), pages 974-997, December.
    3. Wolman, Alexander L, 2005. "Real Implications of the Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 273-296, April.
    4. Steve Ambler, 2009. "Is It Time For Price‐Level Targeting?," Economic Affairs, Wiley Blackwell, vol. 29(3), pages 35-39, September.
    5. Binder, Carola Conces, 2018. "Inflation expectations and the price at the pump," Journal of Macroeconomics, Elsevier, vol. 58(C), pages 1-18.
    6. Seçkin Kabak & Tuðçe Dallý, 2023. "Gibson Paradox: Panel Data Analysis on ASEAN-T Countries," International Econometric Review (IER), Econometric Research Association, vol. 15(1), pages 12-27, March.
    7. David Longworth & Brian O´Reilly, 2002. "The Monetary Policy Transmission Mechanism and Policy Rules in Canada," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 13, pages 357-392, Central Bank of Chile.

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