Abstract
This chapter presents the Gibson paradox and the term structure of interest rates. Because inflation is usually associated with extreme changes in an economic system, it has long stimulated the analytical curiosity of economists. One interesting problem is the behavior of market interest rates during a period of inflation. It has been thought that a good understanding of the cause of this relationship would provide the means to answering the questions of the origin of the business cycle and whether changes in the supply of money can permanently change variables, such as the real rate of interest. The demand for these funds was seen largely to come from those desiring to make capital investments. To this could be added the demand by government to finance a budget deficit and the desire by individuals to hoard money. The supply of these funds comes from saving, new-money creation, government budget surpluses, and the dishoarding of money. The interplay of demand and supply determines the market rate of interest. In the absence of inflation and expectations of inflation, the market rate was also the real rate of interest.
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